Commodities Market Module

&
NCFM Module Examination Details
Allowable access to Candidate at
Sr. Module Name Test No. Of Maxi- Nega- Pass Test Centre
NO Dura- Ques- mum tive marks Normal Regular
tion (in tions Marks Mark- Open Distri- /Sci- Finan-
min- ing Office bution entific cial
utes) Spread Table Calcu- Calcu-
Sheet lator lator

FOUNDATION
1 Financial Markets: A Beginners’ Module 120 60 100 NO 50 NO NO YES NO
2 Mutual Funds : A Beginners' Module 120 60 100 NO 50 NO NO YES NO
3 Currency Derivatives: A Beginner’s Module 120 60 100 NO 50 NO NO YES NO
4 Equity Derivatives: A Beginner’s Module 120 60 100 NO 50 NO NO YES NO
5 Interest Rate Derivatives: A Beginner’s Module 120 60 100 NO 50 NO NO YES NO
6 Commercial Banking in India: A Beginner’s Module 120 60 100 NO 50 NO NO YES NO
7 FIMMDA-NSE Debt Market (Basic) Module 120 60 100 YES 60 YES NO YES NO
8 Securities Market (Basic) Module 120 60 100 YES 60 NO NO YES NO
9 Clearing Settlement and Risk Management Module 60 75 100 NO 60 YES NO YES NO
10 Banking Fundamental - International 90 48 48 YES 29 YES NO YES NO
11 Capital Markets Fundamental - International 90 40 50 YES 30 YES NO YES NO
INTERMEDIATE
1 Capital Market (Dealers) Module 105 60 100 YES 50 NO NO YES NO
2 Derivatives Market (Dealers) Module 120 60 100 YES 60 NO NO YES NO
3 Investment Analysis and Portfolio Management 120 60 100 YES 60 NO NO YES NO
4 Fundamental Analysis Module 120 60 100 YES 60 NO NO YES NO
5 Operation Risk Management Module 120 75 100 YES 60 NO NO YES NO
6 Options Trading Strategies Module 120 60 100 YES 60 NO NO YES NO
7 Banking Sector Module 120 60 100 YES 60 NO NO YES NO
8 Treasury Management Module 120 60 100 YES 60 YES NO YES NO
9 Insurance Module 120 60 100 YES 60 NO NO YES NO
10 Macroeconomics for Financial Markets Module 120 60 100 YES 60 NO NO YES NO
11 NSDL–Depository Operations Module # 75 60 100 YES 60 NO NO YES NO
12 Commodities Market Module 120 60 100 YES 50 NO NO YES NO
13 Surveillance in Stock Exchanges Module 120 50 100 YES 60 NO NO YES NO
14 Technical Analysis Module 120 60 100 YES 60 NO NO YES NO
15 Mergers and Acquisitions Module 120 60 100 YES 60 NO NO YES NO
16 Back Office Operations Module 120 60 100 YES 60 NO NO YES NO
17 Wealth Management Module 120 60 100 YES 60 NO NO YES NO
18 Project Finance Module 120 60 100 YES 60 NO NO YES NO
19 Venture Capital and Private Equity Module 120 70 100 YES 60 NO NO YES NO
20 Financial Services Foundation Module ### 120 45 100 YES 50 NO NO YES NO
21 NSE Certified Quality Analyst $ 120 60 100 YES 50 NO NO YES NO
22 NSE Certified Capital Market Professional (NCCMP) 120 60 100 NO 50 NO NO YES NO
ADVANCED
1 Algorithmic Trading Module 120 100 100 YES 60 YES NO YES NO
2 Financial Markets (Advanced) Module 120 60 100 YES 60 YES NO YES NO
3 Securities Markets (Advanced) Module 120 60 100 YES 60 YES NO YES NO
4 Derivatives (Advanced) Module 120 55 100 YES 60 YES YES YES NO
5 Mutual Funds (Advanced) Module 120 60 100 YES 60 YES NO YES NO
6 Options Trading (Advanced) Module 120 35 100 YES 60 YES YES YES YES
7 Retirement Analysis and Investment Planning 120 77 150 NO 50 YES NO YES YES
8 Retirement Planning and Employee Benefits ** 120 77 150 NO 50 YES NO YES YES
9 Tax Planning and Estate Planning ** 120 77 150 NO 50 YES NO YES YES
10 Investment Planning ** 120 77 150 NO 50 YES NO YES YES
11 Examination 5/Advanced Financial Planning ** 240 30 100 NO 50 YES NO YES YES
12 Equity Research with Financial Modelling## 120 54 60 YES 60 YES NO YES YES
13 Financial Valuation and Modeling 120 100 100 YES 60 YES NO YES YES
14 Mutual Fund and Fixed Income Securities Module 120 100 60 YES 60 YES NO YES YES
15 Issue Management Module ## 120 55 70 YES 60 YES NO YES NO
16 Market Risk Module ## 120 40 65 YES 60 YES NO YES NO
17 Financial Modeling Module ### 120 30 100 YES 50 YES NO YES NO
18 Business Analytics Module ### 120 66 100 NO 50 YES NO YES NO

#: Candidates securing 80% or more marks in NSDL-Depository Operations Module ONLY will be certified as
‘Trainers’.
###: Module of IMS Proschool
##: Modules of Finitiatives Learning India Pvt. Ltd. (FLIP)
**: Financial Planning Standards Board Ltd (Certified Financial Planner Certification)
$ : SSA Business School

The curriculum for each of the modules (except Modules of Financial Planning Standards Board Limited, Finitiatives
Learning India Pvt. Ltd. and IMS Proschool) is available on our website: www.nseindia.com
Preface
About NSE Academy
NSE Academy is a subsidiary of National Stock Exchange of India. NSE Academy straddles the entire
spectrum of financial courses for students of standard VIII and right up to MBA professionals. NSE
Academy has tied up with premium educational institutes in order to develop pool of human resources
having right skills and expertise, which are apt for the financial market. Guided by our mission of spreading
financial literacy for all, NSE Academy has constantly innovated its education template; this has resulted
in improving the financial well-being of people at large in society. Our education courses have so far
facilitated more than 41.8 lakh individuals become financially smarter through various initiatives.

NSE Academy’s Certification in Financial Markets (NCFM)

NCFM is an online certification program aimed at upgrading skills and building competency. The program
has a widespread reach with testing centers present at more than 154+ locations across the country.

The NCFM offers certifications ranging from the Basic to Advanced. One can register for the NCFM
through:

 Online mode by creating an online login id through the website www.betnseindia.com

‘Learn>‘Overview’ > ‘NSE Academy Certification modules’>NEW NCFM Registration available on
the website www.nseindia.com.
 Offline mode by filling up registration form available on the website www.nseindia.com
Learn>Overview >How to take a test>Registration Form.

Once registered, a candidate is allotted a unique NCFM registration number along with an online login id
and can avail of facilities like SMS alerts, online payment, checking of test schedules, online enrolment,
profile update etc. through their login id.
About NCDEX Institute of Commodity Markets and Research

NCDEX Institute of Commodity Markets and Research (NICR) is a 100 per cent subsidiary of the National
Commodity & Derivatives Exchange (NCDEX), the leading Agri derivatives market platform of the country.

NICR is dedicated to promoting research and awareness in commodity markets.. NICR offers a variety of
certification courses through offline and online modes, the open-enrolment courses, as well as customised
educational programmes anywhere in India. These courses are open to anyone, right from a novice to an
expert seeking to understand and learn about the Agri commodity and derivatives market.

The online courses are designed to make stakeholders understand the commodity derivatives market; its
purpose, the importance of risk management and price discovery through self-learning mode. The details
are available at NICR Education Page.

Page 2
Distribution of weights of the Commodities Market Module Curriculum

Chapter Title Weights (%)

No.
1. Introduction to Derivatives 6
2. Commodity Derivatives 7
3. The NCDEX Platform 5
4. Commodities traded on the NCDEX Platform 3
5. Instruments available for trading 15
6. Pricing commodity futures 6
7. Using commodity futures 14
8. Trading 13
9. Clearing and Settlement 17
10. Regulatory Framework 8
11. Taxes 3
12. Electronic Spot Market 3

All content included in this book, such as text, graphics, logos, images, data compilation etc. are the property of NICR.
This book or any part thereof should not be copied, reproduced, duplicated, sold, resold or exploited for any commercial
purposes. Furthermore, the book in its entirety or any part cannot be stored in a retrieval system or transmitted in any
form or by any means, electronic, mechanical, photocopying, recording or otherwise.

Page 3
CONTENTS

Module 1 : Introduction to Derivatives 9

1.1 Derivatives Defined 9
1.2 Products, Participants and Functions 10
1.3 Derivatives Markets 11
1.3.1 Spot versus Forward Transaction 12
1.3.2 Exchange Traded Versus OTC Derivatives 13
1.3.3 Some Commonly Used Derivatives 14
1.4 Difference between Commodity and Financial Derivatives 15
1.4.1 Physical Settlement 16
1.4.2 Warehousing 17
1.4.3 Quality of Underlying Assets 18
Module 2 : Commodity Derivatives 20
2.1 Evolution of Commodity Exchanges 20
2.1.1 Commodity Exchange 20
2.1.2 Role of Commodity Exchanges 20
2.1.3 Commodity Derivative Markets in India 21
2.1.4 Indian Commodity Exchanges 27
2.2 Global Commodity Derivatives Exchanges 31
2.2.1 Leading Commodity Exchanges across the Globe 32
Module 3 : The NCDEX Platform 35
3.1 Structure of NCDEX 36
3.1.1 Shareholders of NCDEX 36
3.1.2 Governance 37
3.1.3 NCDEX Products 38
3.1.4 Initiatives 38
3.2 Spot Price Polling 39
3.2.1 Polling and Bootstrapping 40
3.2.2 Cleansing of Data 41
3.2.3 Outsourcing of Polling 41
3.2.4 Validation & Checks on the Polling Processes 42
3.2.5 Independence of the Polling Agency 42
3.2.6 Dissemination of Spot Price Data as a Service 43
3.3 Exchange Membership 43
3.3.1 Capital Requirement 44

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 3.3.2 Other Requirements 45
3.4 Risk Management 46
3.5 Clearing and Settlement System 46
3.5.1 Clearing 46
3.5.2 Settlement 47
3.5.3 Clearing Days and Scheduled Time 47
Module 4 : Commodities Traded on the NCDEX Platform 48
4.1 Commodities Traded on NCDEX 48
4.2 Contract Specifications 49
Module 5 : Instruments Available for Trading 57
5.1 Forward Contracts 57
5.1.1 Limitations of Forward Markets 58
5.2 Futures Contract 58
5.2.1 Distinction between Futures and Forward Contracts 59
5.2.2 Futures Terminology 60
5.3 Option Contract 61
5.3.1 Option Terminology 62
5.4 Basic Payoffs 64
5.4.1 Payoff for Buyer: Long Position 64
5.4.2 Payoff for Seller: Short Position 65
5.5 Payoff for Futures 66
5.5.1 Payoff for Buyer of Futures: Long Futures 66
5.5.2 Payoff for Seller of Futures: Short Futures 67
5.6 Payoff for Options 68
5.6.1 Payoff for Buyer of Call Options: Long Call 68
5.6.2 Payoff for Writer of Call Options: Short Call 69
5.6.3 Payoff for Buyer of Put Options: Long Put 71
5.6.4 Payoff for Writer of Put Options: Short Put 72
5.7 Using Futures Versus Using Options 74
Module 6 : Pricing Commodity Futures 75
6.1 Investment Assets Versus Consumption Assets 75
6.2 The Cost of Carry Model 76
6.2.1 Pricing Futures Contracts on Investment Commodities 78
6.2.2 Pricing Futures Contracts on Consumption Commodities 81
6.3 The Futures Basis 82
Module 7 : Using Commodity Futures 84
7.1 Hedging 84

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 7.1.1 Basic Principles of Hedging 84
7.1.2 Short Hedge 85
7.1.3 Long Hedge 86
7.1.4 Hedge Ratio 88
7.1.5 Advantages of Hedging 89
7.1.6 Limitation of Hedging: Basis Risk 90
7.2 Speculation 91
7.2.1 Speculation: Bullish Commodity, Buy Futures 91
7.2.2 Speculation: Bearish Commodity, Sell Futures 92
7.3 Arbitrage 92
7.3.1 Overpriced Commodity Futures: Buy Spot, Sell Futures 93
7.3.2 Underpriced Commodity Futures: Buy Futures, Sell Spot 93
Module 8 : Trading 95
8.1 Futures Trading System 95
8.2 Entities in The Trading System 96
8.2.1 Guidelines for Allotment of Client Code 97
8.3 Commodity Futures Trading Cycle 97
8.4 Order Types and Trading Parameters 97
8.4.1 Time Conditions 98
8.4.2 Price Condition 99
8.4.3 Other Conditions 99
8.4.4 Permitted Lot Size 100
8.4.5 Tick Size for Contracts & Ticker Symbol 100
8.4.6 Quantity Freeze 101
8.4.7 Base Price 102
8.4.8 Price Ranges of Contracts 102
8.4.9 Trading Screen 103
8.4.10 Order Entry on the Trading System 103
8.5 Margins for Trading in Futures 104
8.6 Charges 106
8.6.1 Rate of Charges 106
8.6.2 Due Date 106
8.6.3 Collection Process 106
8.6.4 Registration with BJPL and their Services 106
8.6.5 Adjustment against Advance Transaction Charges 107
8.6.6 Penalty for Delayed Payments 107
8.7 Hedge Limits 107

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 8.8 Broad SEBI Guidelines Issued In 2016 for Hedging 107
Module 9 : Clearing and Settlement 110
9.1 Clearing 110
9.1.1 Clearing House 110
9.1.2 Clearing Relationships 111
9.1.3 Functions of a Clearing House 111
9.2 Settlement 116
9.2.1 Mark to Market (MTM) settlement 116
9.2.2 Final settlement 117
9.3 Cash Settlement 129
9.4 Risk Management 129
9.4.1 Credit Risk 130
9.4.2 Settlement Risk 132
9.4.3 Fixing Position Limits 134
9.4.4 Fixing Exposure Limits 134
9.4.5 Fixing Intra-day Price Limit 138
9.4.6 Near Month Limits 139
9.4.7 Additional Base Capital 139
9.4.8 Real-time Monitoring and Alert System 140
9.4.9 Member Deposit Fund 141
Module 10 : Regulatory Framework 142
10.1 The Securities Contract Regulation Act 1956 145
10.2 Rules Governing Commodity Derivatives Exchanges 147
10.3 Rules Governing Intermediaries 148
10.3.1 Trading 148
10.3.2 Trading Members and Users 149
10.3.3 Trading Days 149
10.3.4 Opening of Contracts 150
10.3.5 Contract Expiration 150
10.3.6 Trading Parameters 150
10.3.7 Failure of Trading Member Terminal 151
10.3.8 Trade Operations 151
10.3.9 Margin Requirements 151
10.3.10 Unfair Trading Practices 152
10.3.11 Clearing 152
10.3.12 Last Day of Trading 153
10.3.13 Delivery 153

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 10.3.14 Procedure for Payment of Applicable Taxes 154
10.3.15 Payment through the Clearing Bank(S) 154
10.3.16 Clearing and Settlement Process 154
10.4 Rules Governing Investor Grievances, Arbitration 157
10.4.1 Procedure for Arbitration 158
10.4.2 Hearings and Arbitral Award 158
Module 11 : Taxes 160
11.1 Commodity Transaction Tax (CTT) 160
11.2 Taxation Updates Post 2018-19 Budget: 161
11.3 Goods and Services Tax (GST) 161
11.3.1 Settlement on Account of GST 162
11.3.2 Invoicing 162
Module 12 : Electronic Spot MARKET 164
12.1 Need for Electronic Online Spot Market 164
12.1.1 E-Pledge Helps in Financial Inclusion 165
12.1.2 Facilitating Farmer Producer Organizations (FPOs) 166
12.1.3 Enabling Government Meets Its Social Objectives 166
12.1.4 Regulations 166
12.2 Service 166
12.2.1 E-Pledge 166
12.2.2 Warehouse and Supply Chain 168
12.2.3 Comlive 169
Module 13 Model Test Paper 170
13.1 Questions 170
13.2 Correct Answers 183
Module 14 Notes 184

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Module 1 : Introduction to Derivatives
The origin of derivatives can be traced back to the need of farmers to protect themselves against
fluctuations in the price of their crop. From the time of sowing to the time of crop harvest, farmers would
face price uncertainty. Through the use of simple derivative products, it was possible for the farmer to
partially or fully transfer price risks by locking-in asset prices. These were simple contracts developed to
meet the needs of farmers and were basically a means of reducing risk.

A farmer who sowed his crop in June faced uncertainty over the price he would receive for his harvest in
September. In years of scarcity, he would probably obtain attractive prices. However, during times of
oversupply, he would have to dispose off his harvest at a very low price. Clearly this meant that the farmer
and his family were exposed to a high risk of price uncertainty.

On the other hand, a merchant with an ongoing requirement of grains too would face a price risk - that of
having to pay exorbitant prices during dearth, although favourable prices could be obtained during periods
of oversupply. Under such circumstances, it clearly made sense for the farmer and the merchant to come
together and enter into a contract whereby the price of the grain to be delivered in September could be
decided earlier. What they would then negotiate happened to be a futures-type contract, which would
enable both parties to eliminate the price risk.

In 1848, the Chicago Board of Trade (CBOT) was established to bring farmers and merchants together. A
group of traders got together and created the `to-arrive' contract that permitted farmers to lock in to price
upfront and deliver the grain later. These to-arrive contracts proved useful as a device for hedging and
speculation on price changes. These were eventually standardised, and in 1925 the first futures clearing
house came into existence.

Today, derivative contracts exist on a variety of commodities such as corn, pepper, cotton, wheat, silver,
etc. Besides commodities, derivatives contracts also exist on a lot of financial underlying like stocks, interest
rate, exchange rate, etc.

1.1 Derivatives Defined

A derivative is a product whose value is derived from the value of one or more underlying variables or
assets in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset.
In our earlier discussion, we saw that wheat farmers may wish to sell their harvest at a future date to
eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The
price of this derivative is driven by the spot price of wheat which is the 'underlying' in this case.

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The Forward Contracts (Regulation) Act, 1952, which regulated the forward/ futures contracts in
commodities all over India, empowered the Forward Markets Commission (FMC) to have jurisdiction over
commodity forward/ futures contracts. However, when derivatives trading in securities was introduced in
2001, the term 'security' in the Securities Contracts (Regulation) Act, 1956 (SCRA), was amended to
include derivative contracts in securities. Consequently, regulation of derivatives came under the purview
of Securities Exchange Board of India (SEBI). The Forward Markets Commission (FMC) was regulating
the commodity futures trading in India until September 2015. In September 2015, the FMC was merged
with the SEBI. This resulted in the Forward Contracts (Regulation) Act (FCRA) repealed and the regulation
of the commodity derivatives market shifted to SEBI under the Securities Contracts Regulation Act (SCRA),
1956.

While the FMC regulated only the exchanges and had no direct control over brokers, SEBI has a far superior
surveillance, risk-monitoring, and enforcement mechanism, which gives more confidence to market
participants.

In India, the Securities Contract Regulation Act (SCRA) 1956 governs the trading of all financial derivatives
in our country.

The SCRA has defined derivatives to include:

 A security derived from a debt instrument, share, loan whether secured or unsecured, risk
investment or contract for differences or any other form of security

 A contract that derives its value from the prices, or index of prices, of underlying securities

1.2 Products, Participants and Functions

Derivative contracts are of different types. The most common ones are forwards, futures, options and
swaps. Participants who trade in the derivatives market can be classified under the following three broad
categories: hedgers, speculators, and arbitragers.

 Hedgers: The farmer's example that we discussed about was a case of hedging. Hedgers face risk
associated with the price of an asset. They use the futures or options markets to reduce or eliminate
this risk.

 Speculators: Speculators are participants who wish to bet on future movements in the price of an
asset. Futures and options contracts can give them leverage; that is, by putting in small amounts
of money upfront, they can take large positions on the market. As a result of this leveraged
speculative position, they increase the potential for large gains as well as large losses.

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  Arbitragers: Arbitragers work at making profits by taking advantage of discrepancy between prices
of the same product across different markets. If, for example, they see the futures price of an asset
getting out of line with the cash price, they would take offsetting positions in the two markets to lock
in the profit.

Whether the underlying asset is a commodity or a financial asset, derivatives market performs a number of
economic functions.

 Prices in an organised derivatives market reflect the perception of market participants about the
future and lead the prices of underlying to the perceived future level. The prices of derivatives
converge with the prices of the underlying at the expiration of the derivative contract. Thus,
derivatives help in discovery of future as well as current prices.

 The derivatives market helps to transfer risks from those who have them but may not like them to
those who have an appetite for them.

 Derivatives, due to their inherent nature, are linked to the underlying cash markets. With the
introduction of derivatives the underlying market witnesses higher trading volumes, because of
participation by more players who would not otherwise participate for lack of an arrangement to
transfer risk.

 Speculative traders shift to a more controlled environment of the derivatives market. In the absence
of an organised derivatives market, speculators trade in the underlying cash markets. Margining,
monitoring and surveillance of the activities of various participants become extremely difficult in
these kinds of mixed markets.

 An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new
entrepreneurial activity. Derivatives have a history of attracting many bright, creative, well-educated
people with an entrepreneurial attitude. They often energize others to create new businesses, new
products and new employment opportunities, the benefit of which are immense.

 Derivatives markets help increase savings and investment in the long run. The transfer of risk
enables market participants to expand their volume of activity.

1.3 Derivatives Markets

Derivatives markets can broadly be classified as commodity derivatives market and financial derivatives
markets. As the name suggest, commodity derivatives markets trade contracts are those for which the
underlying asset is a commodity. It can be an agricultural commodity like wheat, soybeans, rapeseed,
cotton, etc. or precious metals like gold, silver, etc. or energy products like crude oil, natural gas, coal,
electricity etc. Financial derivatives markets trade contracts have a financial asset or variable as the

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underlying. The more popular financial derivatives are those which have equity, interest rates and
exchange rates as the underlying. The most commonly used derivatives contracts are forwards, futures
and options which we shall discuss in detail later.

Box 1.1 Emergence of financial derivative products

Derivative products initially emerged as hedging devices against fluctuations in commodity prices and
commodity-linked derivatives remained the sole form of such products for almost three hundred
years. Financial derivatives came into the spotlight in the post-1970 period due to growing instability
in the financial markets. However, since their emergence, these products have become popular and
by 1990s, they accounted for about two - thirds of total transactions in derivative products.

In recent years, the market for financial derivatives has grown tremendously in terms of instruments
available, their complexity and also turnover. In the class of equity derivatives the world over, futures
and options on stock indices have gained more popularity than on individual stocks, especially among
institutional investors, who are major users of index- linked derivatives. Even small investors find
these useful due to high correlation of the popular indexes with various portfolios and ease of use.
The lower costs associated with index derivatives vis-à-vis derivative products based on individual
securities is another reason for their growing use.

1.3.1 Spot versus Forward Transaction

Every transaction has three components - trading, clearing and settlement. A buyer and seller come
together, negotiate and arrive at a price. This is trading. Clearing involves finding out the net outstanding,
that is exactly how much of goods and money the two should exchange. For instance, A buys goods worth
Rs.100 from B and sells goods worth Rs. 50 to B. On a net basis, A has to pay Rs. 50 to B. Settlement is
the actual process of exchanging money and goods. Using the example of a forward contract, let us try to
understand the difference between a spot and derivatives contract.

In a spot transaction, the trading, clearing and settlement happens instantaneously, i.e. 'on the spot'.
Consider this example. On 1st June 2019, Aditya wants to buy some gold. The goldsmith quotes Rs. 32,000
per 10 grams. They agree upon this price and Aditya buys 20 grams of gold. He pays Rs.64,000, takes the
gold and leaves. This is a spot transaction.

Now suppose, Aditya does not want to buy the gold on the 1st June, but wants to buy it a month later. The
goldsmith quotes Rs. 32,200 per 10 grams. They agree upon the 'forward' price for 20 grams of gold that
Aditya wants to buy and Aditya leaves. A month later, he pays the goldsmith Rs. 64,400 and collects his
gold. This is a forward contract, a contract by which two parties irrevocably agree to settle a trade at a

Page 12
future date, for a stated price and quantity. No money changes hands when the contract is signed. The
exchange of money and the underlying goods only happens at the future date as specified in the contract.
In a forward contract, the process of trading, clearing and settlement does not happen instantaneously.
The trading happens today, but the clearing and settlement happens at the end of the specified period.

A forward contract is the most basic derivative contract. We call it a derivative because it derives value
from the price of the asset underlying the contract, in this case- gold. If on the 1st of July, gold trades for
Rs. 32,500 per 10 grams in the spot market, the contract becomes more valuable to Aditya because it now
enables him to buy gold at Rs.32,200 per 10 grams. If however, the price of gold drops down to Rs. 31,800
per 10 grams he is worse off because as per the terms of the contract, he is bound to pay Rs. 32,200 per
10 grams for the same gold. The contract has now lost value from Aditya's point of view. Note that the
value of the forward contract to the goldsmith varies exactly in an opposite manner to its value for Aditya.

1.3.2 Exchange Traded Versus OTC Derivatives

Derivatives have probably been around for as long as people have been trading with one another. Forward
contracting dates back at least to the 12th century and may well have been around before then. These
contracts were typically Over the Counter (OTC) kind of contracts. Over the counter derivatives are privately
negotiated contracts. Merchants entered into contracts with one another for future delivery of specified
amount of commodities at specified price. A primary motivation for prearranging a buyer or seller for a stock
of commodities in early forward contracts was to lessen the possibility that large swings would inhibit
marketing the commodity after a harvest.

The OTC derivatives markets have the following features compared to exchange-traded derivatives:

 The management of counter-party (credit) risk is decentralised and located within individual
institutions.

 There are no formal centralised limits on individual positions, leverage, or margining.

 There are no formal rules for risk and burden-sharing.

 There are no formal rules or mechanisms for ensuring market stability and integrity, and for
safeguarding the collective interests of market participants.

The OTC contracts are generally not regulated by a regulatory authority and the exchange's self-regulatory
organisation, although they are affected indirectly by national legal systems, banking supervision and
market surveillance.

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The derivatives markets have witnessed rather sharp growth over the last few years, which have
accompanied the modernisation of commercial and investment banking and globalisation of financial
activities. The recent developments in information technology have contributed to a great extent to these
developments. While both exchange-traded and OTC derivative contracts offer many benefits, the former
have rigid structures compared to the latter.

The largest OTC derivative market is the inter-bank foreign exchange market. Commodity derivatives, the
world over are typically exchange-traded and not OTC in nature.

Box 1.2: History of Commodity Derivatives Markets

Early forward contracts in the US addressed merchants' concerns about ensuring that there were buyers
and sellers for commodities. However, 'credit risk' remained a serious problem. To deal with this problem,
a group of Chicago businessmen formed the Chicago Board of Trade (CBOT) in 1848. The primary
intention of the CBOT was to provide a centralized location known in advance for buyers and sellers to
negotiate forward contracts. In 1865, the CBOT went one step further and listed the first 'exchange traded'
derivatives contract in the US, these contracts were called 'futures contracts'. In 1919, Chicago Butter
and Egg Board, a spin-off of CBOT, was reorganized to allow futures trading. Its name was changed to
Chicago Mercantile Exchange (CME). The CBOT and CME remain the two largest organized futures
exchanges, indeed the two largest 'financial' exchanges of any kind in the world today.

The first stock index futures contract was traded at Kansas City Board of Trade. Currently, the most
popular stock index futures in the world is based on S&P 500 index, traded on Chicago Mercantile
Exchange. During the mid eightees, financial futures became the most active derivative instruments
generating volumes many times more than the commodity futures. Index futures, futures on T-bills and
Euro-Dollar futures are the three most popular futures contracts traded today. Other popular international
exchanges that trade derivatives are LIFFE in Europe, DTB in Germany, SGX in Singapore, TIFFE in
Japan, MATIF in France, Eurex etc.

Later many of these contracts were standardised in terms of quantity and delivery dates and began to
trade on an exchange

1.3.3 Some Commonly Used Derivatives

Here we define some of the more popularly used derivative contracts. Some of these, namely futures and
options will be discussed in more details at a later stage.

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  Forwards: A forward contract is an agreement between two entities to buy or sell the underlying
asset at a future date, at today's pre-agreed price.

 Futures: A futures contract is an agreement between two parties to buy or sell the underlying asset
at a future date at today's future price. Futures contracts differ from forward contracts in the sense
that they are standardised and exchange traded.

 Options: There are two types of options - call and put. A Call option gives the buyer the right but
not the obligation to buy a given quantity of the underlying asset, at a given price on or before a
given future date. A Put option gives the buyer the right, but not the obligation to sell a given quantity
of the underlying asset at a given price on or before a given date.

 Warrants: Options generally have lives of up to one year, the majority of options traded on options
exchanges having a maximum maturity of nine months. Longer-dated options are called warrants
and are generally traded over-the-counter.

 Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is
usually a weighted average of a basket of assets. Equity index options are a form of basket options.

 Swaps: Swaps are private agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts. The
two commonly used swaps are:

 Interest rate swaps: These entail swapping only the interest related cash flows between the
parties in the same currency.

 Currency swaps: These entail swapping both principal and interest between the parties, with
the cash flows in one direction being in a different currency than those in the opposite direction.

1.4 Difference between Commodity and Financial Derivatives

The basic concept of a derivative contract remains the same whether the underlying happens to be a
commodity or a financial asset. However, there are some features which are very peculiar to commodity
derivative markets. In the case of financial derivatives, most of these contracts are cash settled. Since
financial assets are not bulky, they do not need special facility for storage even in case of physical
settlement. On the other hand, due to the bulky nature of the underlying assets, physical settlement in
commodity derivatives creates the need for warehousing. Similarly, the concept of varying quality of asset
does not really exist as far as financial underlying are concerned. However, in the case of commodities,
the quality of the asset underlying a contract can vary largely. This becomes an important issue to be
managed. We have a brief look at these issues.

Page 15
 COMMODITY DERIVATIVES FINANCIAL DERIVATIVES

Commodity derivatives may be settled by actual Financial derivatives are only cash settled on the
deliveries of underlying physical goods given day

Quantity and quality differences exist No quantity and quality differences exist

Holding cost includes assaying, warehousing and Holding cost normally consists of only interest
insurance costs apart from cost of capital, i.e. costs
Interest

Physical markets are seasonal in nature Financial markets are active throughout the year

Factors impacting: Factors impacting:

• Demand and supply • Global and local economic conditions

• Import-export regulations • Performance of the entity
• Government intervention • Taxation structure
• Interest rate expectations

1.4.1 Physical Settlement

Physical settlement involves the physical delivery of the underlying commodity, typically at an accredited
warehouse. The seller intending to make delivery would have to take the commodities to the designated
warehouse and the buyer intending to take delivery would have to go to the designated warehouse and
pick up the commodity. This may sound simple, but the physical settlement of commodities is a complex
process. The issues faced in physical settlement are enormous. There are limits on storage facilities in
different states. There are restrictions on interstate movement of commodities. The process of taking
physical delivery in commodities is quite different from the process of taking physical delivery in financial
assets.

We take a general overview at the process flow of physical settlement of commodities. Later on in chapter
9, we will look into the details of physical settlement through the Exchange providing platform for commodity
derivatives trading, National Commodity and Derivatives Exchange Limited (NCDEX).

Delivery Notice Period

Unlike in the case of equity futures, typically a seller of commodity futures has the option to give notice of
delivery. This option is given during a period identified as `delivery notice period'.

Page 16
Assignment

Whenever delivery notices are given by the seller, the clearing house of the Exchange identifies the buyer
to whom this notice may be assigned. Exchanges follow different practices for the assignment process.

Delivery

The procedure for buyer and seller regarding the physical settlement for different types of contracts is
clearly specified by the Exchange. The period available for the buyer to take physical delivery is stipulated
by the Exchange. Buyer or his authorised representative in the presence of seller or his representative
takes the physical stocks against the delivery order. Proof of physical delivery having been effected is
forwarded by the seller to the clearing house and the invoice amount is credited to the seller's account.

The clearing house decides on the delivery order rate at which delivery will be settled. Delivery rate depends
on the spot rate of the underlying adjusted for discount/ premium for quality and freight costs. The discount/
premium for quality and freight costs are published by the clearing house before introduction of the contract.
The most active spot market is normally taken as the benchmark for deciding spot prices.

1.4.2 Warehousing

One of the main differences between financial and commodity derivative is the need for warehousing. In
case of most exchange-traded financial derivatives, all the positions are cash settled. Cash settlement
involves paying up the difference in prices between the time the contract was entered into and the time the
contract was closed. For instance, in case of stock futures, if a trader buys futures of a stock at Rs.100 and
on the day of expiration the futures on that stock close at Rs.120, he does not really have to buy the
underlying stock. All he does is take the difference of Rs.20 in cash. Similarly, the person who sold this
futures contract at Rs.100 does not have to deliver the underlying stock. All he has to do is pay up the loss
of Rs.20 in cash.

In case of commodity derivatives however, there is a possibility of physical settlement. It means that if the
seller chooses to hand over the commodity instead of the difference in cash, the buyer must take physical
delivery of the underlying asset. This requires the Exchange to make an arrangement with warehouses to
handle the settlements. The efficacy of the commodities settlements depends on the warehousing system
available. Such warehouses have to perform the following functions:

 Earmark separate storage areas as specified by the Exchange for storing commodities;
 Ensure proper grading of commodities before they are stored;
 Store commodities according to their grade specifications and validity period; and
 Ensure that necessary steps and precautions are taken to ensure that the quantity and grade of
commodity, as certified in the warehouse receipt, are maintained during the storage period. This receipt
can also be used as collateral for financing.

Page 17
NCDEX have developed an indigenous accounting system for commodities traded on NCDEX, it is called
E-Repository. It helps in dematerializing commodities kept in Warehouses.

Warehousing Development and Regulatory Authority (WDRA) has been set up by the Government of India
under the Warehousing (Development & Regulation) Act, 2007 with the objective of development and
regulation of warehouses including registration and accreditation of the warehouses facilitating issuance of
negotiable warehouse receipts in the country. All the warehouses should be registered with WDRA, without
which no warehouse in India can issue negotiable warehouse receipt as per the provisions of Warehousing
(Development & Regulation) Act, 2007. Currently there are 115 agricultural and 26 horticulture commodities
including cereals, pulses, spices, vegetable oil seeds etc. are notified, for the issuance of negotiable
warehouse receipts. NCDEX accredited warehouses are also registered with WDRA. The Exchange
encourages the registration of warehouses under WDRA, thus they play an important role in establishing
robust warehousing ecosystem across country.

1.4.3 Quality of Underlying Assets

A derivatives contract is written on a given underlying. Variance in quality is not an issue in case of financial
derivatives as the physical attribute is missing. When the underlying asset is a commodity, the quality of
the underlying asset is of prime importance. There may be quite some variation in the quality of what is
available in the marketplace. When the asset is specified, it is therefore important that the Exchange
stipulate the grade or grades of the commodity that are acceptable. Commodity derivatives demand good
standards and quality assurance/ certification procedures. A good grading system allows commodities to
be traded by specification.

Trading in commodity derivatives also requires quality assurance and certifications from specialized
agencies. In India, for example, the Bureau of Indian Standards (BIS) under the Department of Consumer
Affairs specifies standards for processed agricultural commodities.

The Food Safety and Standards Authority of India (FSSAI) frames science based standards for various
food article. FSSAI regulates and supervises the functioning of food businesses in India, to monitor and
promote public health. Currently, commodity derivative contracts are also mandated to adhere to the FSSAI
compliant quality specifications. The standards are quite specific in case of those commodities, which are
meant for human consumption.

Page 18
Box. 1.3 Specifications of some commodities underlying derivatives contracts

The Intercontinental Exchange (ICE) has specified for its orange juice futures contract "US Grade A
with a Brix value of not less than 62.5 degrees".

The Chicago Mercantile Exchange (CME) in its random length lumber futures contract has specified
that "Each delivery unit shall consist of nominal 2x4's of random lengths from 8 feet to 20 feet. Each
delivery unit shall consist of and be grade stamped #1 or #2 AND BETTER. Each delivery unit shall
be manufactured in California, Idaho, Montana, Nevada, Oregon, Washington, Wyoming, or Alberta or
British Columbia, Canada, and contain lumber produced from and grade stamped Hem Fir (except
that Hem-Fir shall not be deliverable if it is manufactured in Canada; nor that portion of Washington
including and to the west of Whatcom, Skagit, Snohomish, King, Pierce, Lewis and Skamania
counties; nor that portion of Oregon including and to the west of Multnomah, Clackamas, Marion,
Linn, Lane, Douglas and Jackson counties; nor that portion of California west of Interstate Highway 5
nor south of US Highway 50), Englemann Spruce, Lodgepole Pine, Englemann Spruce/Lodgepole
Pine and/or Spruce Pine Fir (except that Spruce-Pine-Fir shall not be deliverable if it is manufactured in
those portions of Washington, Oregon and California that are noted above)".

Page 19
Module 2 : Commodity Derivatives
Derivatives as a tool for managing risk first originated in the commodities markets. They were then found
useful as a hedging tool in financial markets as well. In India, trading in commodity futures has been in
existence from the nineteenth century with organised trading in cotton through the establishment of Cotton
Trade Association in 1875. Over a period of time, other commodities were permitted to be traded in futures
exchanges. Regulatory constraints in 1960s resulted in virtual dismantling of the commodity futures market.
It is only in the last decade that commodity futures exchanges have been actively encouraged. In this
chapter, we take a brief look at the global commodity markets and the commodity markets that exist in
India.

2.1 Evolution of Commodity Exchanges

Most of the commodity exchanges, which exist today, have their origin in the late 19th and earlier 20th
century. The first central exchange was established in 1848 in Chicago under the name Chicago Board of
Trade. The emergence of the derivatives markets as the effective risk management tools in 1970s and
1980s has resulted in the rapid creation of new commodity exchanges and expansion of the existing ones.
At present, there are major commodity exchanges all over the world dealing in different types of
commodities.

2.1.1 Commodity Exchange

Commodity exchanges are defined as centers where futures trade is organized in a wider sense; it is taken
to include any organized market place where trade is routed through one mechanism, allowing effective
competition among buyers and among sellers. This would include auction-type exchanges, but not
wholesale markets, where trade is localized, but effectively takes place through many non-related individual
transactions between different permutations of buyers and sellers.

2.1.2 Role of Commodity Exchanges

Commodity exchanges provide platforms to suit the varied requirements of customers. Firstly, they help in
price discovery as players get to set future prices which are also made available to all participants. Hence,
a farmer in the southern part of India would be able to know the best price prevailing in the country which
would enable him to take informed decisions. For this to happen, the concept of commodity exchanges
must percolate down to the villages. Today the farmers base their choice for next year's crop on current
year's price. Ideally this decision ought to be based on expected price at the time of harvest. Futures prices
on the platforms of commodity exchanges will hopefully move farmers of our country from the current
'cobweb' effect where additional acreage comes under cultivation in the year subsequent to one when a

Page 20
commodity had good prices; consequently the next year the commodity price actually falls due to
oversupply.

Secondly, these exchanges enable actual users (farmers, agro processors, industry where the predominant
cost is commodity input/output cost) to hedge their price risk given the uncertainty of the future - especially
in agriculture where there is uncertainty regarding the monsoon and hence prices. This holds good also for
non-agro products like metals or energy products as well where global forces could exert considerable
influence. Purchasers are also assured of a fixed price which is determined in advance, thereby avoiding
surprises to them. It must be borne in mind that commodity prices in India have always been woven firmly
into the international fabric. Today, price fluctuations in all major commodities in the country mirror both
national and international factors and not merely national factors.

Thirdly, by involving the group of investors and speculators, commodity exchanges provide liquidity and
buoyancy to the system.

Lastly, the arbitrageurs play an important role in balancing the market as arbitrage conditions, where they
exist, are ironed out as arbitrageurs trade with opposite positions on different platforms and hence generate
opposing demand and supply forces which ultimately narrows down the gaps in prices.

It must be pointed out that while the monsoon conditions affect the prices of agro-based commodities, the
phenomenon of globalization has made prices of other products such as metals, energy products, etc.,
vulnerable to changes in global politics, policies, growth paradigms, etc. This would be strengthened as
the world moves closer to the resolution of the WTO impasse, which would become a reality shortly.
Commodity exchanges would provide a valuable hedge through the price discovery process while catering
to the different kind of players in the market.

2.1.3 Commodity Derivative Markets in India

Commodity futures markets have a long history in India. Cotton was the first commodity to attract futures
trading in the country leading to the setting up of the Bombay Cotton Trade Association Ltd in 1875. The
Bombay Cotton Exchange Ltd. was established in 1893 following the widespread discontent amongst
leading cotton mill owners and merchants over the functioning of Bombay Cotton Trade Association.

Subsequently, many exchanges came up in different parts of the country for futures trading in various
commodities. Futures trading in oilseeds started in 1900 with the establishment of the Gujarati Vyapari
Mandali, which carried on futures trade in groundnut, castor seed and cotton.

Before the Second World War broke out in 1939, several futures markets in oilseeds were functioning in
Gujarat and Punjab.

Page 21
Futures trading in wheat existed at several places in Punjab and Uttar Pradesh, the most notable of which
was the Chamber of Commerce at Hapur, which began futures trading in wheat in 1913 and served as the
price setter in that commodity till the outbreak of the Second World War in 1939.

Futures trading in bullion began in Mumbai in 1920 and subsequently markets came up in other centres
like Rajkot, Jaipur, Jamnagar, Kanpur, Delhi and Kolkata.

Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in raw jute and jute goods. But
organized futures trading in raw jute began only in 1927 with the establishment of East Indian Jute
Association Ltd. These two associations amalgamated in 1945 to form the East India Jute & Hessian Ltd.
to conduct organized trading in both raw jute and jute goods. In due course several other exchanges were
also created in the country to trade in such diverse commodities as pepper, turmeric, potato, sugar and gur
(jaggery).

After independence, with the subject of `Stock Exchanges and futures markets' being brought under the
Union list, responsibility for regulation of commodity futures markets devolved on Government of India. A
Bill on forward contracts was referred to an expert committee headed by Prof. A. D. Shroff and select
committees of two successive Parliaments and finally in December 1952, Forward Contracts (Regulation)
Act, 1952, was enacted.

The Act provided for 3-tier regulatory system:

(a) An association recognized by the Government of India on the recommendation of

Forward Markets Commission,
(b) The Forward Markets Commission (it was set up in September 1953) and
(c) The Central Government.

Box 2.1 According to FC(R) Act, commodities are divided into 3 categories with reference to extent
of regulation, viz:

 Commodities in which futures trading can be organized under the auspices of recognized
association.

 Commodities in which futures trading is prohibited.

 Commodities which have neither been regulated nor prohibited for being traded under the
recognized association are referred as Free Commodities and the association organized in such
free commodities is required to obtain the Certificate of Registration from the Forward Markets
Commission.

Page 22
Forward Contracts (Regulation) Rules were notified by the Central Government in July, 1954.

India was in an era of physical controls since independence and the pursuance of a mixed economy set up
with socialist proclivities had ramifications on the operations of commodity markets and commodity
exchanges. Government intervention was in the form of buffer stock operations, administered prices,
regulation on trade and input prices, restrictions on movement of goods, etc. Agricultural commodities were
associated with the poor and were governed by polices such as Minimum Price Support and Government
Procurement. Further, as production levels were low and had not stabilized, there was the constant fear of
misuse of these platforms which could be manipulated to fix prices by creating artificial scarcities. This was
also a period which was associated with wars, natural calamities and disasters which invariably led to
shortages and price distortions. Hence, in an era of uncertainty with potential volatility, the government
banned futures trading in commodities in the 1960s.

The Khusro Committee which was constituted in June 1980 had recommended reintroduction of futures
trading in most of the major commodities, including cotton, kapas, raw jute and jute goods and suggested
that steps may be taken for introducing futures trading in commodities, like potatoes, onions, etc. at
appropriate time. The government, accordingly initiated futures trading in Potato during the latter half of
1980 in quite a few markets in Punjab and Uttar Pradesh.

With the gradual trade and industry liberalization of the Indian economy pursuant to the adoption of the
economic reform package in 1991, GOI constituted another committee on Forward Markets under the
chairmanship of Prof. K.N. Kabra. The Committee which submitted its report in September 1994
recommended that futures trading be introduced in the following commodities:

• Basmati Rice
• Cotton, Kapas, Raw Jute and Jute Goods
• Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, safflower
seed, copra and soybean and oils and oilcakes
• Rice bran oil
• Castor oil and its oilcake
• Linseed
• Silver
• Onions

The committee also recommended that some of the existing commodity exchanges particularly the ones in
pepper and castor seed, may be upgraded to the level of international futures markets.

UNCTAD and World Bank joint Mission Report "India: Managing Price Risk in India's Liberalized
Agriculture: Can Futures Market Help? (1996)" highlighted the role of futures markets as market based

Page 23
instruments for managing risks and suggested the strengthening of institutional capacity of the Regulator
and the exchanges for efficient performance of these markets.

Another major policy statement, the National Agricultural Policy, 2000, also expressed support for
commodity futures. The Expert Committee on Strengthening and Developing Agricultural Marketing (Guru
Committee: 2001) emphasized the need for and role of futures trading in price risk management and in
marketing of agricultural produce. This Committee's Group on Forward and Futures Markets recommended
that it should be left to interested exchanges to decide the appropriateness/usefulness of commencing
futures trading in products (not necessarily of just commodities) based on concrete studies of feasibility on
a case-to-case basis. It, however, noted that all the commodities are not suited for futures trading. For a
commodity to be suitable for futures trading it must possess some specific characteristics.

The liberalized policy being followed by the Government of India and the gradual withdrawal of the
procurement and distribution channel necessitated setting in place a market mechanism to perform the
economic functions of price discovery and risk management.

The National Agriculture Policy announced in July 2000 and the announcements of Hon'ble Finance
Minister in the Budget Speech for 2002-2003 were indicative of the Government’s resolve to put in place a
mechanism of futures trade/market. As a follow up, the Government issued notifications on 1.4.2003
permitting futures trading in the commodities, with the issue of these notifications futures trading is not
prohibited in any commodity. Options trading in commodity is, however presently prohibited.

The year 2003 is a landmark in the history of commodity futures market witnessing the establishment and
recognition of three new national exchanges [National Commodity and Derivatives Exchange of India Ltd.
(NCDEX), Multi Commodity Exchange of India Ltd (MCX) and National Multi Commodity Exchange of India
Ltd. (NMCE)] with on-line trading and professional management. Not only was prohibition on forward
trading completely withdrawn, the new exchanges brought capital, technology and innovation to the market.

These markets depicted phenomenal growth in terms of number of products on offer, participants, spatial
distribution and volume of trade. Majority of the trade volume is contributed by the national level exchanges
whereas regional exchanges have a very less share.

With developments on way, the commodity futures exchanges registered an impressive growth till it saw
the first ban of two pulses (Tur and Urad) towards the end of January 2007. Subsequently the ban of two
more commodities from cereals group i.e. Wheat and Rice in the next month. The commodity market
regulator, Forward Markets Commission as a measure of abundant caution, suspended futures trading in
Chana, Soya oil, Rubber and Potato w.e.f. May 7, 2008. However, with the easing of inflationary pressure,
the suspension was allowed to lapse on November 30, 2008. Trading in these commodities resumed on
December 4, 2008. Later on futures trading in wheat was re-introduced in May 2009. These bans affected
participants' confidence adversely. In May 2009, futures trading in sugar was suspended. Due to mistaken

Page 24
apprehensions that futures trading contributes to inflation, futures trading in rice, urad, tur and sugar has
been temporarily suspended.

Box 2.2 : Futures Trading

The Government of India had appointed a committee under the chairmanship of Prof. Abhijit Sen,
Member, Planning Commission to study the impact of futures trading, if any, on agricultural commodity
prices. The Committee was appointed on March 2, 2007 and submitted its report on April 29, 2008. The
main findings and recommendations of the committee are: negative sentiments have been created by the
decision to delist futures trades in some important agricultural commodities; the period during which
futures trading has been in operation is too short to discriminate adequately between the effect of opening
of futures markets, if any, and what might simply be the normal cyclical adjustments in prices; Indian data
analyzed does not show any clear evidence of either reduced or increased volatility; the vibrant agriculture
markets including derivatives markets are the frontline institutions to provide early signs of future
prospects of the sector. The committee recommended for upgradation of regulation by passing of the
proposed amendment to FC(R) Act 1952 and removal of infirmities in the spot market (Economic Survey,
2009-10).

The "Study on Impact of Futures Trading in Wheat, Sugar, Pulses and Guar Seeds on Farmers" was
commissioned by the Forward Markets Commission and undertaken by the Indian Institute of Management,
Bangalore. While the study was primarily intended to find out how futures trading is helping major
stakeholders in the value chain of these commodities; it also dealt with the impact of futures trading on the
prices of these commodities. The study did not find any visible link between futures trading and price
movement and suggested that the main reason for price changes seemed to be changes in the
fundamentals (mainly on the supply side) of these commodities, Price changes were also attributed to
changes in government policies.

There being widespread consensus that the commodity derivatives market required an independent,
effective, and well-functioning regulatory system. Many of the existing provisions of the Forward Contracts
Regulation Act, 1952 (FCRA Act) have become redundant in view of the rapid expansion of the commodity
futures markets. This necessitated changes in the organisational structure. There was also a growing
demand for allowing trading in commodity options for risk management. In response to this need, in the
Union Budget for 2015-16 announced merger of Forward Markets Commission (FMC) with the Securities
and Exchange Board of India (SEBI) in order to strengthen regulation of commodity forward/future markets.
Effective 28 September 2015, the Forward Markets Commission (FMC) was merged with Securities and
Exchange Board of India (SEBI). This ushered in era of common regulator for Capital Markets and
Commodity Markets. However, it is worth mentioning that countries like USA has separate regulator for

Page 25
Capital Markets (Securities and Exchange Commission (SEC) and Commodity Futures Trading
Commission (CFTC) for Commodity markets)

This was the first ever merger of two regulators in the country. This historic merger paved the way to
implement an array of new reforms towards developing commodity derivatives market with superior and
efficient technology, risk management, supervision, surveillance, enforcement, and liquidity and investor
protection.

After taking over the regulation of the commodities market, SEBI has initiated numerous progressive steps
to strengthen the commodity derivatives ecosystem in the country. Few of these reform are enlisted below:

 New norms for exchange approved WSPs, warehouses and assayers : to strengthen the delivery
infrastructure;
 Revised the criteria for eligibility, retention and re-introduction of derivative contracts on
Exchanges;
 Issued guidelines w.r.t. providing additional position limits for Hedgers;
 Issued norms on the Settlement Guarantee Fund
 Prescribed the framework for staggered delivery, early delivery, early pay-in facility
 Issued norms for delivery default penalty, fixing of the final settlement price (FSP) and in some
cases change in expiry dates of futures contracts.

Further, in order to deepen and widen the commodity market, the SEBI took a series of initiatives such as
allowing hedge funds to invest in commodity derivatives and allowing the introduction of safer products
such as commodity options to provide alternative hedging instrument to farmers. Recently, bank’s
subsidiaries were also allowed to provide broking services and be a professional clearing member.
However, banks themselves are not yet permitted to trade in commodity derivatives. SEBI has also issued
detailed norms with regard to the Investor Protection Fund (IPF) and related matters.

With these progressive reform initiatives, the SEBI tried to reduce the risks in the commodity ecosystem,
widening the participants and products to further deepen the commodity derivatives segment and bringing
it at par with securities market. It has produced positive results and able to increase the investors’
confidence and attract participation from hedgers.

Mandating the registration of portfolio managers, investment advisers and research analysts: In a move to
safeguard Indian markets from any manipulative research reports or misleading advice coming from any
unregulated entities, SEBI notified norms for ‘research analysts’ i.e. SEBI (Research Analysts) Regulations,
2014, to ward off any conflict of interest in their activities. As on March 31, 2018, there were 476 research
analysts registered with SEBI.

Page 26
2.1.4 Indian Commodity Exchanges

There were SIX national commodity futures Exchanges and around 20 regional commodity exchanges in
India. However, Indian commodity market faced a tough time during 2012 -2015 when introduction of
Commodity Transaction Tax (CTT) resulted in a squeeze of the trading volume on the bourses. While, the
SEBI, initiated a series of initiatives to widen the market and increase the depth, the response from the
market participants remained slow. Universal Commodity Exchange Limited (UCX), the latest entrant, was
the sixth national level commodity exchange that started its operation in 2012. It has surrendered its license
in 2014. It was allowed by SEBI to exit in 2017-18.

National Multi Commodity Exchange of India Ltd. (NMCE), one of the oldest commodity exchanges in India,
merged with Indian Commodity Exchange Limited (ICEX) in 2018. Another national Exchange, Ace
Derivatives and Commodity Exchange Limited (ACE) has also surrendered its trading license to SEBI
owing to low trading volumes.

Apart from national commodity exchanges, there were regional commodity exchanges such as Hapur
Commodity Exchange Limited, Spices and Oilseeds Exchange Limited (SOE), Rajkot Commodity
Exchange Limited, India Pepper and Spice Trade Association (IPSTA) etc. were offering trading in certain
specific commodities. SEBI, in order to make commodity market more efficient, has prescribed the
minimum criteria of turnover and also specified various terms and conditions that exchanges have to
comply failing which exchanges need to surrender their recognition. Being commodity specific exchanges
and unable to comply with these compliance requirements specified by SEBI, such as 100 crore capital for
commodity-specific regional exchanges, forced them to pull down the shutters for futures trading.
Accordingly, Spice and Oilseeds Exchange Limited, Rajkot Commodity Exchange Limited, and India
Pepper Spice Trade Association were allowed by SEBI to exit during 2017-18.

In a recent reform, the market regulator SEBI allowed convergence of stock and commodity bourse from
October 2018. This has paved the way for major equity exchanges like BSE, NSE to introduce commodity-
backed financial instruments on their platforms, while commodity exchanges such as MCX and NCDEX
are allowed to list equities and equity derivatives. Accordingly, on October 1, 2018, BSE became the first
stock exchange in the country to launch the commodity derivative contracts.

Presently following Exchanges are offering commodity derivatives at the national level:

1. National Commodity and Derivatives Exchange Ltd. (NCDEX), Mumbai

2. Multi Commodity Exchange of India Ltd. (MCX), Mumbai
3. Indian Commodity Exchange Limited (ICEX), New Delhi
4. Bombay stock Exchange (BSE), Mumbai
5. National Stock Exchange (NSE), Mumbai

Page 27
The indicative market share* of leading Indian Commodity Exchanges for 2018-19 is presented in figure:

Exchange-wise % share* of market value in 2018-19

ICEX NMCE
0.33% 0.17%

NSE
NCDEX 0.01%
8%

BSE
0.10%

MCX
92%

BSE ICEX MCX NCDEX NMCE NSE

Market Share of Indian Commodity Exchanges in 2018-19

*Note:
1. BSE and NSE commenced offering commodity derivatives from October 2018 and therefore the
graphs and tablse contain the data from October 2018 onwards.
2. NMCE was merged with ICEX in September 2018.
3. Data shown in the table above is meant for the academic purpose only. The information contained
herein is taken from publicly available data or other sources believed to be reliable. Please visit the
website of respective exchanges to know the exact turnover value.

Turnover* on Commodity Exchanges (in Rs. Crore)

Exchanges 2018-19 2017-18 2016-17
BSE 7,253 - -
ICEX 23,606 2,130 -
MCX 6,624,179 5,300,819 5,865,661
NCDEX 531,418 589,497 596,852
NMCE 12,527 34,591 28,283
NSE 901 - -

Page 28
The indicative market share* of Agricultural Commodity Derivatives on leading Indian Commodity
Exchanges for 2018-19 is presented in figure:

Exchange-wise % share of Agricultural Commodities market value in 2018-19

NMCE BSE ICEX MCX

1.93% 0.58% 0.16%
15%

NCDEX
82%

BSE ICEX MCX NCDEX NMCE NSE

Market Share of Agricultural Commodity on Indian Commodity Exchanges in 2018-19

Agricultural Commodity Derivatives Turnover* on Indian Commodity Exchanges (in Rs. Crore)
Exchanges 2018-19
BSE 3,772
ICEX 1,058
MCX 100,260
NCDEX 531,418
NMCE 12,527
NSE

Page 29
A comprehensive list of the registered Commodity Exchanges in India with the major commodities traded
as on June 2019 is given below.

EXCHANGE COMMODITIES TRADED

National Commodity & Derivatives Exchange Futures:

Ltd., Mumbai Barley, Castor Seed, Chana, Cotton, Cottonseed

oilcake, Crude Palm Oil, Dhaniya, Guar gum,
Guar seed, Jeera, Kapas, Maize, RM Seed,
Sugar, Turmeric, Soybean, Soy refined oil,
Wheat.

Options:

Guar seed, Guar Gum, Soybean, Chana, Refined

Soy Oil
Multi Commodity Exchange of India Ltd., Mumbai Futures:

Gold, Silver, Crude Oil, Natural Gas, Copper,

Lead, Zinc, Nickel, Aluminium, Brass, Black
pepper, Cotton, Cardamom, Castor seed, Crude
Palm Oil, Menth oil, RBD Palmolein, Rubber

Options:

Gold, Silver, Copper, Zinc, Crude Oil

Indian Commodity Exchange Limited (ICEX), Futures:

New Delhi Black Pepper, Cardamom, Castor Seed, Copra,

Mustard seed, Soya Bean Oil, Rubber, Raw Jute,
Jute sack, Isabgul seed, Guar seed, Diamonds,
Steel
Bombay Stock Exchange (BSE), Mumbai Futures:

Gold, Silver, Copper, Cotton, Guar seed and guar

gum
National Stock Exchange of India (NSE), Mumbai Futures:

Gold, Silver and Brent crude oil

*Note: Please visit the website of respective exchanges to know the detailed list of all the products traded.

The growth in commodity futures trade has led to an upsurge of interest in a number of associated fields,
viz. research, education and training activities in commodity markets, commodity reporting for print and
visual media, collateral management, commodity finance, ware-housing, assaying and certification,

Page 30
software development, electronic spot exchanges etc. Markets and fields almost non-existent some years
ago now attract significant mind-share nationally and internationally.

2.2 Global Commodity Derivatives Exchanges

Globally commodity derivatives exchanges have existed for a long time. The evolution of the exchanges
was fuelled by the needs of businessmen and farmers. The need was to make the process of buying and
selling commodities easier by bringing the buyers and sellers together. In the US, the development of
modern futures trading began in the early 1800s. This development was tied closely to the development of
commerce in Chicago, which started developing as a grain terminal. At that time, supply and demand
imbalances were normal. There was a glut of commodities at harvest time in some years and severe
shortages during years of crop failure. Difficulties in transportation and lack of proper storage facilities
aggravated the problem of demand and supply imbalances.

The uncertain market conditions led farmers and merchants to contract for forward delivery. Some of the
first forward contracts were in corn. To reduce the price risk of storing corn in winter, these merchants went
to Chicago in spring and entered into forward contracts with processors for the delivery of grain. The grain
was received from farmers in late fall or early winter. The earliest recorded forward contract was on March
13, 1851. As the grain trade expanded, a group of 82 merchants gathered at a flour store in Chicago to
form the Chicago Board of Trade (CBOT). CBOT started the "to arrive" forward contract, which permitted
farmers to lock in the price and deliver the grain much later. The exchange's early years saw the dominance
of forward contracts. However, certain drawbacks of forwards such as lack of standardization and non-
fulfillment of commitments made CBOT take steps in 1865 to formalize grain trading.

By the mid 19th century, futures markets had developed into effective mechanisms for managing
counterparty and price risks. The clearinghouse of the exchange guaranteed the performance of contracts
and started collecting margins to ensure contract performance. Trading practices were further formalized
as contracts started getting more refined and rules of conduct and procedures for clearing and settlement
were established.

New exchanges were formed in the late 19th and early 20th centuries as trading started in non-agricultural
commodities such as precious metals and processed products, among others. Financial innovations in the
post-Bretton Woods period led to trading in financial futures, the most successful contract in the futures
industry. Financial derivatives became important due to the rising uncertainty in the post-1970s period,
when the US announced the end of the Bretton Woods System of fixed exchange rates. This led to the
introduction of currency derivatives followed by other innovations including stock index futures.

Commodities' trading in some developing economies also has a long history. The Buenos Aires Grain
Exchange in Argentina (founded in 1854) is one of the oldest in the world. Though developing countries
saw the early use of commodity risk-management instruments, increased government intervention and

Page 31
policies impeded the development of futures markets. Failure of government-led price-stabilisation
schemes and the adoption of liberalisation and globalisation policies since the 1980s have contributed to
the resurgence of commodity markets in these countries.

2.2.1 Leading Commodity Exchanges across the Globe

Country Exchange
United States of America Chicago Board of Trade (CBOT)
Chicago Mercantile Exchange (CME)
Minneapolis Grain Exchange (MGEX)
New York Cotton Exchange (NYCE)
New York Mercantile Exchange (NYMEX)
Kansas City Board of Trade (KCBT)
New York Board of Trade (NYBOT)
Canada The Winnipeg Commodity Exchange (WCE)
Brazil Brazilian Mercantile and Futures Exchange (BM&F)
Australia Sydney Futures Exchange Ltd.(SFE)
People’s Republic Of China Beijing Commodity Exchange (BCE)
Dalian Commodity Exchange (DCE)
Shanghai Futures Exchange (SHFE)
Zhengzhou Commodity Exchange (CZCE)
Hong Kong Hong Kong Futures Exchange (HKFE)
India National Commodity and Derivatives Exchange (NCDEX)
Multi Commodity Exchange (MCX)
Japan Tokyo International Financial Futures Exchange (TIFFE)
Kansai Agricultural Commodities Exchange (KACE)
Tokyo Grain Exchange (TGE)
Malaysia Kuala Lumpur Commodity Exchange (KLCE)
New Zealand New Zealand Futures & Options Exchange Ltd. (NZFOE)
Singapore Singapore Commodity Exchange Ltd. (SICOM)
France Le Nouveau Marche MATIF
Italy Italian Derivatives Exchange Market (IDEM)
Netherlands Amsterdam Exchanges Option Traders (AEOT)
Russia MICEX/Relis Online, St. Petersburg Futures Exchange (SPBFE)
Spain The Spanish Options Exchange (SOE)
Citrus Fruit and Commodity Futures Market of Valencia (CFCFMV)

Page 32
 United Kingdom The London International Financial Futures Options Exchange (LIFFE)
The London Metal Exchange (LME)

Recent years have seen spate of mergers/acquisitions globally as well as in Indian scenario. For example,
CME acquired CBOT – (both Chicago based exchanges and now CBOT functions as division of CME). In
Indian scenario, ACE is not functional now. SEBI permitted NSE and BSE to launch Commodities
segments. In nutshell, one has to understand that such changes keep on happening in market place.

Readers are advised to keep themselves updated from time to time, since globally mergers of exchanges
keep on happening and new exchanges keep coming up in emerging economies like Indonesia, Uganda,
and Ghana etc.

A summary of leading global derivative Exchanges and the commodities traded on them is presented in
following table:

Name Contracts Traded

Chicago Mercantile
Exchange (CME)
New York Mercantile
Exchange (NYMEX)
London International
Financial Futures and
Options Exchange (LIFFE)
Chicago Board of Trade
(CBOT)
London Metal Exchange
(LME)
New York Board of Trade
(NYBOT)
Tokyo Commodity
Exchange (TOCOM)
Sydney Futures Exchange
(SFE)
Dubai Gold and
Commodities Exchange
(DGCX)
Bursa Malaysia Berhad
Winnipeg Commodity
Exchange
Dalian Commodity
Exchange
Butter, milk, di-ammonium phosphate, feeder cattle, frozen pork
bellies, lean hogs, live cattle, non-fat dry milk, urea, urea ammonium
nitrate among others
Light sweet crude oil, natural gas, heating oil, gasoline, RBOB gasoline,
electricity, propane, gold, silver, copper, aluminium, platinum, palladium
and the like
Cocoa, Robusta coffee, corn, potato, rapeseed, white sugar, feed wheat,
milling wheat and the like
Corn, soybeans, soybean oil, soybean meal, wheat, oats, ethanol, rough
rice, gold, silver, among others
Aluminium, copper, nickel, lead, tin, zinc, aluminium alloy, North American
Special aluminium Alloy (NASAAC), polypropylene, linear, low-density
polyethylene and the like
Cocoa, coffee, cotton, ethanol, sugar, frozen concentrated orange juice,
pulp and so on
Gasoline, kerosene, crude oil, gold, silver, platinum, palladium, aluminum
and rubber among others
Greasy wool, fine wool, broad wool, cattle
Gold, silver, fuel oil, steel, freight rates, cotton and so on
Refined bleached deodorized palmolein, crude palm oil, palm kernel oil,
among others
Canola, feed wheat, western barley
Corn, soybean, soybean meal, soy oil, Iron Ore etc.

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Zhengzhou Commodity Wheat, cotton, sugar
Exchange (ZCE)
Central Japan Commodity Gasoline, kerosene, gas oil, eggs, ferrous scrap
Exchange
Shanghai Futures Copper, Aluminium, natural rubber, plywood and long grained rice
Exchange (SHFE)
Brazilian Mercantile and Anhydrous fuel alcohol, Arabica coffee, Robusta coffee, corn, cotton,
Futures Exchange feeder cattle, live cattle, soybean, crystal sugar, gold
Kansai Commodity Soybean, raw sugar, raw silk, shrimp (frozen), coffee, corn, Azuki beans
Exchange (red)
Osaka Mercantile Exchange (Ribbed Smoked Sheets) RSS3, (Technically Specified Rubber) TSR20,
nickel, Aluminum, Rubber Index

Page 34
Module 3 : The NCDEX Platform
National Commodity & Derivatives Exchange Limited (NCDEX), a national level online multi- commodity
exchange, is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956. It
obtained its Certificate for Commencement of Business on May 9, 2003. It commenced its operations on
December 15, 2003.

NCDEX is a nation-level, technology driven de-mutualised on-line commodity exchange with an

independent Board of Directors and professional management - both not having any vested interest in
commodity markets. It is committed to provide a world-class commodity exchange platform for market
participants to trade in a wide spectrum of commodity derivatives driven by best global practices,
professionalism and transparency.

NCDEX is regulated by Securities and Exchange Board of India. NCDEX is subjected to various laws of
the land like the Securities Contracts (Regulation) Act, 1956, Companies Act, Stamp Act, Contract Act and
various other legislations.

NCDEX currently facilitates trading of 18 commodities. it witnessed an average daily turnover of around Rs
2,377 crore in FY 2018-19. Guar seed held the highest share of 21% followed by Castor seed with a share
of 13% and Soybean seeds at 12%. Other major contributors to the turnover were Chana, Mustard seed,
Jeera etc. The chart below provides the commodity-wise performance of top 5 commodities traded at the
exchange during 2018-19. In Indian context, NCDEX dominates Agri space.

Commodity wise performance (turnover value)

Page 35
NCDEX Exchange Profile

Particular Number Remarks

Products 18 Agri

Active Members 350(*) Spread across India

Terminals about 50,000 Spread across India

Delivery Centers 40 All over the country

Depository Participants 66 Diverse spectrum

Clearing Banks 13 Private as well as Public

(*as on March 31, 2019)

Exchange upgraded their technology in 2017 to match latest globally available technology. NCDEX is in
Mumbai and offers facilities to its members from more than 400 centres throughout India. NCDEX terminals
are connected through VSAT, leased lines and the Internet. The network helps in the discovery of realistic
commodity prices to buyers and sellers in real time. The Exchange provides trading services through leased
lines, VSAT and Internet. Fifty per cent of the trading is through leased lines and Internet and the rest
through VSAT. When commodities exchanges came into being in 2003 telecommunication network was
developing hence there was more dependence on V-sat connectivity especially in far-flung rural areas
where telephone/Wi-Fi networks were not available. There has been a revolutionary change in telecom
services – hence dependence on V-sat has come down. In fact, NCDEX has decided to discontinue V-sat
connectivity w.e.f. March 31,2019.

3.1 Structure of NCDEX

NCDEX has been formed with the following objectives:

• To create a world class commodity exchange platform for the market participants.
• To bring professionalism and transparency into commodity trading.
• To inculcate best international practices like de-materialised technology platforms,
low cost solutions and information dissemination into the trade.
• To provide nationwide reach and consistent offering.
• To bring together the entities that the market can trust.

3.1.1 Shareholders of NCDEX

NCDEX is promoted by a consortium of various institutions. These are Life Insurance Corporation of India
(LIC), National Bank for Agriculture and Rural Development (NABARD), National Stock Exchange of India
Limited (NSE), Canara Bank, Punjab National Bank (PNB), CRISIL Limited, Indian Farmers Fertiliser

Page 36
Cooperative Limited (IFFCO), Goldman Sachs, Intercontinental Exchange (ICE), Shree Renuka Sugars
Limited, Jaypee Capital Services Limited, Build India Capital Advisors LLP, Oman India Joint Investment
Fund, IDFC Private Equity Fund III, Star Agriwarehousing and Collateral Management Limited and
negligible shareholding by individuals.

NCDEX Stakeholders

Sr.No. Name of the shareholder % of total capital

1 National Stock Exchange of India Limited (NSE) 15.00%
2 Life Insurance Corporation of India (LIC) 11.10%
National Bank for Agriculture and Rural Development
3 11.10%
(NABARD)
4 Indian Farmers Fertiliser Cooperative Limited (IFFCO) 10.00%
5 Oman India Joint Investment Fund 10.00%
6 Punjab National Bank (PNB) 7.29%
7 Build India Capital Advisors LLP 6.10%
8 Canara Bank 6.03%
9 IDFC Private Equity Fund III 5.00%
10 Shree Renuka Sugars Limited 5.00%
11 CRISIL Limited 3.70%
12 InterContinental Exchange (ICE) 2.96%
13 Goldman Sachs Investments (Mauritius) I Limited 2.96%
14 Jaypee Capital Services Limited 2.38%
15 Star Agriwarehousing and Collateral Management Ltd. 1.38%
16 Individuals 0.00%
Total 100.00%

All the shareholders bring along with them expertise in closely related fields such as agriculture, rural
banking, co-operative expertise, risk management, intensive use of technology, derivative trading besides
institution building expertise.

3.1.2 Governance

The governance of NCDEX vests with the Board of Directors. None of the Board of Directors has any
vested interest in commodity futures trading. The Board comprises persons of eminence, each an authority
in their own right in the areas very relevant to the Exchange.

The shareholders of the Exchange, in tune with the highest norms of corporate governance, have decided
that they will not be taking part in the day-to-day activities of the Exchange.

NCDEX Board of Directors comprises of 12 Directors who are well known and highly experienced. The
board has constituted committees like Audit Committee, Nomination and Remuneration Committee, Risk

Page 37
Management Committee, Technology Standing Committee, Public Interest Directors’ Committee,
Corporate Social Responsibility, Regulatory Oversight Committee, Stakeholders Relationship Committee,
Member Selection Committee and Advisory Committee, which help the Board in policy formulation.

3.1.3 NCDEX Products

As of May 31, 2019, the Exchange is permitted to offer futures trading in 22 commodity contracts, which
includes 18 agricultural commodity contracts, 1 bullion commodity contract, 1 energy commodity contract
and 2 metals other than bullion contract.

Before identifying a commodity for trading, the Exchange conducts a thorough research into the
characteristics of the product, its market and potential for futures trading. The commodity is recommended
for approval of SEBI, the Regulator for commodity exchanges in the country after approval by the Product
Committee constituted for each of such product and Executive Committee of the Exchange.

3.1.4 Initiatives

NCDEX pioneered constructing NKrishi Index (NCDEX Krishi) - an agricultural futures index. NKrishi is a
value weighted index, computed in real time using the prices of the 10 most liquid commodity futures traded
on the NCDEX platform.

NCDEX is the first commodity exchange in India to provide near real time spot prices of commodities traded
on the Exchange. These prices are polled from various principal market places for the commodity two to
three times a day.

The spot prices that are collected and futures prices that are traded on the Exchange are disseminated
through its website, trader work stations, news agencies such as Reuters, Bloomberg, newspapers and
journals, rural kiosks (e-chaupals and n-Logue), TV channels such as Doordarshan News, and other private
news channels etc.

Price ticker boards have been widely installed by the Exchange to display both real time futures and spot
prices of commodities traded on its platform.

NCDEX has also spearheaded several pilot projects for the purpose of encouraging farmers to participate
on the Exchange and hedge their price risk.

NCDEX took the initiative of establishing a national level collateral management company, National
Collateral Management Services Limited (NCMSL) to take care of the issues of warehousing, standards
and grades, collateral management as well as facilitate commodity finance by banks.

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Within a year of operations, NCDEX has accredited and networked around over 320 delivery centres (now
over 775). Each warehouse has the services of reputed and reliable assayers through accredited agencies.

The Exchange was the first to facilitate holding of commodity balances in an electronic form.

Physical deliveries in an electronic form (demat mode) have taken place in many commodities across the
country.

Physical deliveries of commodities take place through the Exchange platform which presently range
between 30,000-45,000 tonnes every month.

Key milestones

 In 2006- Formation NCDEX spot exchange – National e-Markets Limited (NeML)

 In 2012- Introduction of Staggered Delivery and COMTRACK (Online Commodity tracking and
management system)

 In 2014- Launch of Exchange traded Forward Contract- Agrim Sauda

 In 2015- FPOs initiate trading on NCDEX

 In 2017- Formation of Commodity repository- National E-Repository Limited (NERL)

 In 2018- Launch of the country’s 1st Agri Options by NCDEX

 In 2018- National Commodity Clearing Limited (NCCL) Recognized as Clearing Corporation

3.2 Spot Price Polling

Like any other derivative, a futures contract derives its value from the underlying commodity. The spot and
futures market are closely interlinked with price and sentiment in one market affecting the price and
sentiment in the other.

Fair and transparent spot price discovery attains importance when studied against the role it plays in a
futures market. The availability of spot price data of the basis centers has the following benefits:

 Near real time spot price information helps the trading members to take a view on the future market
and vice versa.

 The data helps the Exchange to analyze the price data concurrently to make meaningful analysis
of price movement in the futures market and helps in the market surveillance function.

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  The Exchange has to track the convergence of spot and futures prices towards the last few days
prior to the expiry of a contract.

 The Exchange need to know the spot prices at around closing time of the contract for the Final
Settlement Price on the expiry day.

 The Exchange needs to know the spot price at the basis center of the underlying commodity of
which the futures are being traded on the platform.

 The near real-time spot price data when it is disseminated by the Exchange is of great interest to
the general public, especially researchers, governmental agencies, international agencies, etc.

In India, there is no effective mechanism or real time spot price information of commodities. The only
government agency which collects spot prices is Agmarknet which collects the post- trade mandi data, but
even such information is not disseminated real time. The Exchange needs the spot price information real
time at several points in time during the trading hours.

Moreover, agricultural spot markets in India are spread over 7,000 mandis across the country. Prices for
the same commodity differ from mandi to mandi. This is a direct consequence of the lack of integration of
markets and the lack of good transportation facilities. The price differentials create a problem in the
development of a unique representative spot price for the commodity.

Considering the importance of spot price information to the trader and the unavailability of reliable source
of real time spot price data, NCDEX has put in place a mechanism to poll spot prices prevailing at various
mandis throughout the country. This process is analogous to the interest rate polling conducted to find the
LIBOR rates.

The Exchange collates spot prices for all commodities on which it offers futures trading and disseminates
the same to the market via the trading platform. This collection and dissemination of spot prices is done by
various reputed external polling agencies which interact directly with market participants and collect
feedback on spot prices which are then disseminated to the market.

3.2.1 Polling and Bootstrapping

Polling is the process of eliciting information from a cross section of market players about the prevailing
price of the commodity in the market. A panel of polling participants comprising various user class viz.
growers, traders/brokers, processors and users is chosen.

Primarily, the data on spot prices is captured at the identified delivery centers which are also termed as the
primary center of a commodity by asking bid and ask quotes from the empanelled polling participants.
Besides the primary center, spot price of a commodity from a couple of other major centers (subject,

Page 40
sometimes, to adequate number of respondents) are also captured. These centers are termed non-primary
or non-priority centers. Multiple-location polling for a commodity helps the Exchange in:

 estimating the price at the primary center when the market there is closed for some reason.

 validating the primary center price when there are reasons to believe that polled data is not reliable
or justified considering the underlying factors.

 providing a value addition to the users.

Polling is carried out once, twice or thrice a day depending upon the market timings, practices at the
physical markets.

When polling for the spot price of a commodity, the participant is asked 'what he thinks is the ASK or BID
price of the commodity conforming to grade and quality specifications of the Exchange. The respondent
may or may not have any buy or sell position of the commodity in the physical market at that point in time.
However since the respondent is an active player in the spot trade of the commodity, he has a clear
understanding of the prevailing price at that point in time.

Considering the vital role the participants play in the process, the polling participants are carefully chosen
to ensure that they are active players in the market. For this reason no association, group of persons or a
trade body/association has been included as polling participant as it is against the spirit of the polling
process.

3.2.2 Cleansing of Data

The spot price polled from each mandi is transmitted electronically to a central database for further process
of bootstrapping to arrive at a clean benchmark average price. To arrive at the bootstrapped price, all the
BID & ASK quotes are sorted in ascending order and through adaptive trimming procedure the extreme
quotes are trimmed from the total quotes. These values are sampled with replacement multiple numbers
of times, where software gives different mean with their respective standard deviation. The mean with least
standard deviation is the spot price that will be uploaded by the polling agency through the polling
application provided by NCDEX. This price is broadcast through the Trader Work Station and also on the
NCDEX website without any human intervention.

3.2.3 Outsourcing of Polling

It is prohibitively expensive for the Exchange to post personnel at various mandis to poll prices especially
in the initial stages when there is no scope to recover any fee from the sale of price data. Further it is
advisable that the spot prices are polled by an agency independently rather than by the Exchange itself for

Page 41
reasons of corporate governance. Thirdly, the agencies chosen will have some expertise and experience
in this field which the Exchange can leverage upon. For the above reasons, NCDEX has outsourced the
processes of polling and bootstrapping to external reputed entities. The Product Managers for the various
commodities are asked to identify through interactions at the mandis the participants who would form a
part of the polling community for a given commodity. They would also explain in detail to the participants
about the Exchange, futures trading, need for polling, the reason why they have chosen the polling
participant, the grade and other quality specifications of the commodity and the name of the polling agency.
After obtaining the concurrence of the participant, the names and contact numbers will be passed on to the
polling agency.

3.2.4 Validation & Checks on the Polling Processes

The Exchange routinely makes daily calls to the polling participants randomly in various commodities and
speak to them about the prices quoted to cross check the raw quotes sent by the polling agency. Besides
they also talk to them about the demand and supply conditions, mandi arrivals, imports/exports activities,
impact of state procurement and agricultural policies, weather conditions impacting the crop, etc. This gives
them a feel of the spot market which is a valuable input in tracking and analyzing futures price movements.

Necessary precaution/checks are maintained at the Exchange so that any spot price which deviates from
the previous day's spot price by +/- 4% is reviewed before uploading. In such case, the Exchange reviews
the raw prices as quoted by respondents available with the polling agency and tries independently to
ascertain the reason for deviation through interaction with the participants. If the price rise/fall is justified
with the feedback received from the participants, the price is uploaded in the system after obtaining
necessary approval. If the price rise/fall is not justified with the feedback received from the participants, the
polling agency is asked to re-poll the prices and the new bootstrapped price is allowed to be uploaded.

Two days prior to the expiry of the contract, the above price limit of 4% will be re-set to 2%. This is done
as a precaution in view of the impending expiry and the high risk of accepting what may be an incorrect
spot price as the FSP. A check is conducted on the lines describe in the previous paragraph before the
prices are uploaded.

It is very important that that the polling participants are periodically reinforced about the grade and quality
specifications set by the Exchange for the commodity for which he is polled and it is the responsibility of
the polling agency to ensure that this is being adhered too.

3.2.5 Independence of the Polling Agency

To ensure impartiality and to remove any biases, the Exchange or its officials have given themselves no
right to alter a spot price provided by the agency.

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3.2.6 Dissemination of Spot Price Data as a Service

NCDEX disseminates the spot price data of underlying commodities traded at the Exchange on its website
www.ncdex.com. This is done at two or three times a day, depending upon the availability of the price data
at the spot market place. The Exchange provides this data as a value added service

3.3 Exchange Membership

Membership of NCDEX is open to any person, association of persons, partnerships, co-operative societies,
companies etc. that fulfills the eligibility criteria set by the Exchange. FIs, NRIs, Banks, MFs etc are not
allowed to participate in commodity exchanges at the moment. All the members of the Exchange have to
register themselves with the competent authority before commencing their operations. NCDEX invites
applications for Members from persons who fulfill the specified eligibility criteria for trading commodities.
The members of NCDEX fall into following categories:

A. Trading cum Clearing Member (TCM) :

Members can carry out the transactions (Trading, clearing and settlement) on their own account and also
on their clients' accounts. Applicants accepted for admission as TCM are required to pay the requisite fees/
deposits and also maintain net worth as explained in the following section.

B. Professional Clearing Members (PCM):

Members can carry out the settlement and clearing for their clients who have traded through TCMs or
traded as TMs. Applicants accepted for admission as PCMs are required to pay the requisite fee/ deposits
and also maintain net worth.

C. Trading Member ( TM ):

Member who can only trade through their account or on account of their clients and will however clear their
trade through PCMs/STCMs.

D. Strategic Trading cum Clearing Member (STCM):

This is up gradation from the TCM to STCM. Such member can trade on their own account, also on account
of their clients. They can clear and settle these trades and also clear and settle trades of other trading
members who are only allowed to trade and are not allowed to settle and clear.

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3.3.1 Capital Requirement

NCDEX has specified capital requirements for its members. Details of deposits/ fees to be paid by
members, accepted for admission to the Commodity Exchange are given in following table:

S. Particulars Trading
Strategic
No cum Professional
Trading cum
Trading Member (TM) Clearing Clearing Member
Clearing
(In Rs.) Member (PCM)(Member of
Member
(TCM) (In NCCL) (In Rs.)
(STCM) ( In Rs)
Rs.)
1 Minimum Net For Non-Corporate
worth (Individuals/Partnership
Firm/LLP/ HUF) - Rs. 10
100.00 Lakh 300.00 Lakh 1000.00 Lakh
Lakh
For Corporates - Rs.25
Lakh
2 Base Capital (NCCL)
i) Interest Free
Cash Security Not Applicable 25.00 Lakh 20.00 Lakh 25.00 Lakh
Deposit
ii) Collateral
Security Not Applicable 25.00 Lakh 50.00 Lakh 25.00 Lakh
Deposit
3 Base Minimum Capital (NCDEX)
i) Interest Free
2.50 Lakh 2.50 Lakh 6.25 Lakh Not Applicable
Cash Deposit
ii) Collateral
7.50 Lakh 7.50 Lakh 18.75 Lakh Not Applicable
Deposit
4 Interest Free
Security
Deposit
(IFSD) 10 Lakh 10 Lakh 10 Lakh Not Applicable
(NCDEX) (in
the form of
cash only)
5 Admission
Fee (one time,
non-
5.00 Lakh 5.00 Lakh 5.00 Lakh 5.00 Lakh
refundable)
(NCDEX) +
Applicable Tax
6 Annual
Membership
Fees 0.20 Lakh 0.75 Lakh 1.00 Lakh 1.00 Lakh
(NCDEX) +
Applicable Tax

Page 44
 7 SEBI
Rs. 0.50
Registration Rs. 0.50 Lakh Rs. 0.50 Lakh Rs. 0.50 Lakh
Lakh
Fees
8 SEBI Annual
Rs. 0.50
Regulatory Not Applicable Rs. 0.50 Lakh Rs. 0.50 Lakh
Lakh
Fees

Notes:

1. Application Processing Fees: Rs. 2,000/- plus applicable Tax

2. If TCM is clearing through STCM/PCM, the member will have to maintain a base capital of Rs. 50 Lakh
with the NCCL in the form of cash only.
3. All clearing members are required to maintain a Minimum Liquid Net worth of Rs 50 lakh at all points
in terms of circular no. NCDEX/RISK-014/2018/194 dated August 07, 2018.No exposure is allowed on
the same.
4. No exposure will be allowed on IFSD (refer circular no NCDEX/MEMBERSHIP-018/2018/190 dated
August 02, 2018) and Base Minimum Capital (refer circular no. NCDEX/RISK-022/2015/319 dated
October 05, 2015 and NCDEX/RISK-033/2016/207 dated September 02, 2016).
5. All clearing members required to maintain a Minimum Liquid Networth of Rs 50 lakh at all points. Kindly
refer to circular no. NCDEX/RISK-014/2018/194 dated August 07, 2018.No exposure will be allowed
on the same.
6. BMC requirement is Rs 50 Lakh for Algo Trading Facility.

3.3.2 Other Requirements

In addition to the capital, fee and deposit requirements, there are some other important requirements to be
fulfilled by all the members falling under different categories which are listed below in the table:

S. Particulars Trading Strategic Profession Trading Member (Rs.) (TM)

No cum Trading al Clearing (Without (With CTCL
Clearing cum Member CTCL Facility)
Member Clearing (PCM) Facility)
(Rs) (TCM) Member (
Rs)
(STCM)
1 CTCL Facility Allowed Allowed - Not allowed Allowed
2 4 type of Bank All 4 type of All 4 type of Settlement Two separate Two separate
Accounts accounts accounts A/c and Bank A/cs - Bank A/cs -
(Settlement A/c , are are Exchange For Client For Client
Exchange Dues A/c, Mandatory Mandatory Dues A/c Trade and Trade and
Own Account , Client Mandatory Own Trades Own Trades
Bank Pool A/c)
3 E-Repository System Mandatory Mandatory Mandatory - -
Accounts

Page 45
 4 Fidelity Insurance Mandatory Mandatory Not Mandatory for Mandatory for
policy for clients' for clients' mandatory clients' trade clients' trade
trade trade

Members are required to open Settlement account and Exchange Dues account with one of clearing bank
(list available on exchange website. Remaining two accounts can be opened in any bank of their choice.

3.4 Risk Management

NCDEX ensures the financial integrity of trades put through on its platform by adopting a comprehensive,
unbiased and professional approach to risk management. NCDEX does not have in its
governing/management team, any person who has any vested interest in commodity trading. The Value at
risk (VaR) based margining and limits on position levels are transparent and applied uniformly across
market participants.

In commodity futures markets, margins are collected from market participants to cover adverse movements
in futures prices. Prudent risk management requires that margining system of the Exchange should
respond to price volatility to ensure that members are able to meet their counter party liability. In the long
run, this ensures financial discipline in the market and aids in the development of the market.

NCDEX provides position monitoring and margining. Position monitoring is carried out on a real-time basis
during the trading hours. Margins are calculated intraday to capture the intra- day volatility in the futures
prices.

Other risk management tools like daily price limits and exposure margins have been adopted in line with
international best practices. Margins are netted at the level of individual client and grossed across all clients,
at the members level, without any set-offs between clients. For orderly functioning of the market, stringent
limits for near month contracts are set.

3.5 Clearing and Settlement System

3.5.1 Clearing

National Commodity Clearing Limited (NCCL) undertakes clearing of trades executed on the NCDEX. Only
clearing members including professional clearing members (PCMs) are entitled to clear and settle contracts
through the clearing house. At NCDEX, after the trading hours on the expiry date, based on the available
information, the matching for deliveries takes place firstly, on the basis of locations and then randomly,
keeping in view the factors such as available capacity of the vault/warehouse, commodities already
deposited and dematerialized and offered for delivery etc. Matching done by this process is binding on the
clearing members. After completion of the matching process, clearing members are informed of the
deliverable/ receivable positions and the unmatched positions. Unmatched positions have to be settled in

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cash. The cash settlement is only for the incremental gain/ loss as determined on the basis of final
settlement price.

3.5.2 Settlement

Futures contracts have two types of settlements, the Mark-to-Market (MTM) settlement which happens on
a continuous basis at the end of the day, and the final settlement which happens on the last trading day of
the futures contract. On the NCDEX, daily MTM settlement in respect of admitted deals in futures contracts
are cash settled by debiting/ crediting the clearing accounts of clearing members (CMs) with the respective
clearing bank. All positions of CM, brought forward, created during the day or closed out during the day,
are mark to market at the daily settlement price or the final settlement price on the contract expiry.

The responsibility of settlement is on a trading cum clearing member for all trades done on his own account
and his client's trades. A professional clearing member is responsible for settling all the participants’ trades
which he has confirmed to the Exchange. Few days before expiry date, as announced by Exchange from
time to time, members submit delivery information through delivery request window on the trader
workstation provided by NCDEX for all open position for a commodity for all constituents individually.
NCDEX on receipt of such information matches the information and arrives at a delivery position for a
member for a commodity. The seller intending to make delivery takes the commodities to the designated
warehouse. These commodities have to be assayed by the Exchange specified assayer. The commodities
have to meet the contract specifications with allowed variances. If the commodities meet the specifications,
the warehouse accepts them. Warehouse then ensures that the receipts get updated in the depository
system giving a credit in the depositor's electronic account. The seller then gives the invoice to his clearing
member, who would courier the same to the buyer's clearing member. On an appointed date, the buyer
goes to the warehouse and takes physical possession of the commodities.

3.5.3 Clearing Days and Scheduled Time

Daily Mark to Market settlement where 'T' is the trading day

Mark to Market Pay-in (Payment): T+1 working day. Mark to Market Pay-out (Receipt): T+1 working day.
Final settlement for Futures Contracts

The settlement schedule for Final settlement for futures contracts is given by the Exchange in detail for
each commodity.

Timings for Funds settlement:

Pay-in: On Scheduled day as per settlement calendars. Pay-out: On Scheduled day as per settlement
calendars.

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Module 4 : Commodities Traded on
the NCDEX Platform
Commodities have been defined by the Forward Contracts (Regulation) Act 1952 as "Every kind of movable
property other than actionable claims, money and securities". Broadly, the commodities tradable on
commodity exchanges in India may be classified into following categories:

1. Vegetable oil seeds, oils and meals

2. Pulses
3. Spices
4. Metals
5. Energy products
6. Vegetables
7. Fibers and manufactures
8. Others

National Commodity and Derivatives Exchange Limited (NCDEX) commenced futures trading in nine major
commodities (gold, silver, cotton, soybean soybean oil, rape/mustard seed, rapeseed oil, crude palm oil
and RBD palmolein) on December 15, 2003. NCDEX is permitted to provide futures trading in both agri
(such as pulses, spices) and non-agri commodities (such as metal, energy, carbon credit, polymers etc.)
belonging to the above mentioned categories. However, currently, it provides futures trading in 18
agricultural commodities (as on May 31, 2019). NCDEX was the first commodity exchange to facilitate
commodities settlement in dematerialized form.

Let us have a brief look in this chapter at the various commodities that trade on the NCDEX and
specifications of some of the commodities available for futures trading at NCDEX.

4.1 Commodities Traded on NCDEX

NCDEX gives priority to commodities that are most relevant to India, and where the price discovery process
takes place domestically. The products chosen are based on certain criteria such as price volatility, share
in GDP, correlation with global markets, share in external trade, warehousing facilities, traders distribution,
geographical spread, varieties etc.

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List of commodities offered for futures and options trading on NCDEX are:

Futures: Options:
Barley, Castor Seed, Chana, Cotton, Cottonseed oilcake, Crude Palm Guar seed, Guar Gum, Soybean,
Oil, Dhaniya, Guar gum, Guar seed, Jeera, Kapas, Maize, RM Seed, Chana, Refined Soy Oil
Sugar, Turmeric, Soybean, Soy refined oil, Wheat

The trade timings on the NCDEX (Monday to Friday) are from 9:00 a.m. to 5:00 p.m. for agricultural products
and for internationally reference-able agri commodities, trading is allowed from 9 a.m. to 9: p.m. The
Exchange may vary the above timing with due notice.

Top five commodities traded on NCDEX during 2018-19

 Guar seed
 Castor seed
 Soyabean
 Guargum
 Chana

4.2 Contract Specifications

For derivatives with a commodity as the underlying, the Exchange specifies the exact nature of the
agreement between two parties who trade in the contract. In particular, it specifies the underlying asset,
unit of trading, price limits, position limits, the contract size stating exactly how much of the asset will be
delivered under one contract, where and when the delivery will be made, etc. Here, we look at the contract
specifications of some of the commodities traded on the Exchange. Contracts specifications of commodities
are revised from time to time in light of changing requirements and feedback of market participants in terms
of product variety, quality, timings, delivery centers, etc.

Most of the agri commodities futures contract traded on NCDEX expire on the 20th of the expiry month.
Thus, a November expiration contract would expire on the 20th of November and a December expiry
contract would cease trading after the 20th of December. If 20th happens to be a holiday, the expiry date
shall be the immediately preceding trading day of the Exchange, other than a Saturday. Some of the
contracts of metals, energy etc. expire on different dates.

Standard Contract Specification for Chana Futures Traded on NCDEX (For Illustration purpose)

Type of Contract Futures Contract

Trading system NCDEX Trading System

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Ticker symbol CHANA
Basis Desi Unprocessed Whole Raw Chana (Not for direct human
consumption) ex-warehouse Bikaner exclusive of GST
Unit of trading 10 MT
Delivery Unit 10 MT
Maximum Order Size 500 MT
Quotation/Base Value Rs. Per Quintal
Tick size Re 1
Quality specification Desi Unprocessed Whole Raw Chana (Not for direct human
consumption)

Desi Unprocessed Whole Raw Chana (Not for direct human

consumption) shall be sound, clean and shall be free from
Mathara, Khesari and live infestation

Foreign matter (other than 1% max

varietal admixture) Chana
with foreign matter not
more than 1% by weight of
which not more than 0.25%
by weight shall be mineral
matter and not more than
0.10% by weight shall be
impurities of animal origin.
Green (Cotyledon color),
Immature, Shrunken, 4% max
Shriveled Seeds
Broken, Splits; 3% max
Damaged 4% max
Weevilled 1% max
Moisture 11% max
Varietal admixture 5% Max

Quantity Variation +/-5%

Delivery center Desi Unprocessed Whole Raw Chana (Not for direct human
consumption) to be delivered at Bikaner (Upto the radius of
60 kms from the municipal limits)
Also deliverable Desi Unprocessed whole Raw Chana (Not for direct human
consumption) can also be delivered at Akola, Jaipur and
Ashok Nagar (Upto the radius of 60 kms from municipal
limit).
Hours of Trading As notified by the Exchange from time to time, currently:-

Mondays through Fridays: 09:00 a.m. to 5:00 p.m.

The Exchange may vary the above timing with due notice.
Delivery Logic Compulsory delivery

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No. of active contracts As per launch calendar
Opening of contracts Trading in any contract month will open on the 1st day of the
month. If 1st day of the month happens to be a non-trading
day, contracts would open on the next trading day.
Tender Period Tender Date –T

Tender Period: The tender period shall start on 11th of every

month in which the contract is due to expire. In case 11th
happens to be a Saturday, a Sunday or a holiday at the
Exchange, the tender period would start from the next
working day.

Pay-in and Pay-out:

On a T+2 basis. If the tender date were T, then pay-in and

payout would happen on T+2 day. If such a T+2 day happens
to be a Saturday, a Sunday or a holiday at the Exchange,
clearing banks or any of the service providers, pay-in and
pay-out would be effected on the next working day.
Closing of contract Clearing and settlement of contracts will commence with the
commencement of Tender Period by compulsory delivery of
each open position tendered by the seller on T + 2 to the
corresponding buyer matched by the process put in place by
the Exchange.

Upon the expiry of the contract all, the outstanding open

position shall result in compulsory delivery.
Due date/Expiry date Expiry date of the contract: 20th day of the delivery month. If
20th happens to be a holiday, a Saturday or a Sunday then
the due date shall be the immediately preceding trading day
of the Exchange.

The settlement of contract would be by a staggered system

of Pay-in and Pay-out including the Last Pay- in and Pay-out,
which would be the Final Settlement of the contract.
Delivery Specification Upon expiry of the contracts all, the outstanding open
positions shall result in compulsory delivery.

During the Tender period, if any delivery is tendered by

seller, the corresponding buyer having open position and
matched as per process put in place by the Exchange, shall
be bound to settle by taking delivery on T + 2 day from the
delivery center where the seller has delivered same.

The penalty structure for failure to meet delivery obligations

will be as per circular no. NCDEX/CLEARING-020/2016/247
dated September 28, 2016 and subsequent modifications if
any notified by the Exchange

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Daily Price Limit (DPL) Daily price limit is (+/-) 3%. Once the 3% limit is reached,
then after a period of 15 minutes this limit shall be increased
further by 1%. The trading shall be permitted during the 15
minutes period within the 3% limit. After the DPL is
enhanced, trades shall be permitted throughout the day
within the enhanced total DPL of 4%

The DPL on the launch (first) day of new contract shall be as

per the circular no. NCDEX/RISK-034/2016/209 dated
September 08, 2016.
Position limits The following limits will be applicable for positions grossed
across all Chana contracts on the Exchange.

Member-wise: 3,00,000 MT or 15% of the market-wide open

interest, whichever is higher.

Client-wise: 30,000 MT

Bona fide hedger clients may seek exemption as per

approved Hedge Policy of the Exchange notified vide
Circular No. NCDEX/CLEARING-019/2016/246 dated
September 28, 2016.

For near month contracts:

The following limits would be applicable from 1st of every

month in which the contract is due to expire. If 1st happens
to be a non-trading day, the near month limits would start
from the next trading day.

Member-wise: 75,000 MT or one-fourth of the member’s

overall position limit in that commodity, whichever is higher.
Client-wise: 7,500 MT.
Premium / Discount Premium/Discount for Chana delivery at additional delivery
centers.

The Premium and discount for different locations shall be

announced by the Exchange before launching of contract.
Special margins In case of unidirectional price movement/ increased volatility,
an additional/ special margin at such other percentage, as
deemed fit by the Regulator/ Exchange, may be imposed on
the buy and the sell side or on either of the buy or sell sides
in respect of all outstanding positions. Reduction/ removal of
such additional/ special margins shall be at the discretion of
the Regulator/ Exchange.

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 Final Settlement Price FSP shall be arrived at by taking the simple average of the
last polled spot prices of the last three trading days viz., E0
(expiry day), E-1 and E-2. In the event the spot price for any
one or both of E-1 and E-2 is not available, the simple
average of the last polled spot price of E0, E-1, E-2 and E-3,
whichever available, shall be taken as FSP. Thus, the FSP
under various scenarios of non-availability of polled spot
prices shall be as under:

Scenario Polled spot price FSP shall be

availability on simple average
E0 E1 E2 E3 of last polled
spot prices on:
1 Yes Yes Yes Yes/No E0,E1,E2
2 Yes Yes No Yes E0,E1,E3
3 Yes No Yes Yes E0,E2,E3
4 Yes No No Yes E0,E3,
5 Yes Yes No No E0,E1
6 Yes No Yes No E0,E2
7 Yes No No No E0
Minimum Initial margin 4%

Compulsory delivery contracts of commodities are the contracts in which all the open positions on the expiry
date need to be compulsorily settled through physical delivery. The penalty structure for failure to meet
delivery obligations is clearly specified by the exchange.

Standard Contract Specification of a Soybean Options contract traded on NCDEX (For Illustration purpose)

Field Description
Underlying 1 lot of SYBEANIDR contract traded on NCDEX

The underlying commodity specifications on devolvement into Futures will be

the same as that mentioned in the contract specifications of underlying Futures.
Symbol <UNDERLYING SYMBOL><OPTIONS EXPIRY DATEDDMMMYY> <CE/PE>
<STRIKE PRICE><UNDERLYINGTYPE-F/S><UNDERLYINGEXPIRY-
MMMYY>

Example: SYBEANIDR10OCT2018CE9000FOCT2018
Options Type European
Premium Quotation / Rs. Per quintal
Base Value
Tick Size Re. 0.5 per quintal

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Expiry Date 10th of the month of expiry of the underlying Futures contract.

If 10th happens to be a holiday, a Saturday or a Sunday then the due date shall
be the immediately preceding trading day of the Exchange.

In case of missing Futures expiry in a particular month, the underlying shall be

the nearest available Futures month.
Options Launch Same as Futures launch Calendar.

Calendar Options contracts shall be launched on the trading day following the day on
which the underlying Futures contracts are launched.
Strike Interval 50
Number of Strikes 5-1-5
Trading Hours Same as underlying Futures contracts.
Daily Price Range Based on the factors of Daily Price Range (DPR) of the underlying Futures
contract and volatility.
Position Limits Numerical value for client level/member level limits in Options shall be twice of
corresponding numbers applicable for Futures contracts.

Soybean: 2,20,000 MT and 22,00,000 MT for clients and members,

respectively.

For near month contracts:

The following limits would be applicable from 1st of every month in which the
contract is due to expire. If 1st happens to be a non-trading day, the near month
limits would start from the next trading day.

 Member-wise: 2,75,000 MT or one-eighth of the member’s overall

position limit in that commodity, whichever is higher.
 Client-wise: 27,500 MT.

Final Settlement Price Daily Settlement Price (DSP) of the underlying Futures contract on the Options
Expiration day.
Exercise of Options European Options to be exercised only on the day of Expiration of the Options
contracts.
Mechanism of Option series having strike price closest to the Daily Settlement Price (DSP) of
Exercise Futures shall be termed as At-the-Money (ATM) option series. This ATM option
series and two option series having strike prices immediately above this ATM
strike and two option series having strike prices immediately below this ATM
strike shall be referred as ‘Close to the money’ (CTM) option series.

In case the DSP is exactly midway between two strike prices, then immediate
two option series having strike prices just above DSP and immediate two option
series having strike prices just below DSP shall be referred as ‘Close to the
money’ (CTM) option series.

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 All option contracts belonging to ‘CTM’ option series shall be exercised only on
‘explicit instruction’ for exercise by the long position holders of such contracts.

All In-the-money (ITM) option contracts, except those belonging to ‘CTM’ option
series, shall be exercised automatically, unless ‘contrary instruction’ has been
given by long position holders of such contracts for not doing so.

All Out of the money (OTM) option contracts, except those belonging to ‘CTM’
option series, shall expire worthless.
Final Settlement On exercise, Option position shall devolve into underlying Futures position as
Method follows:

• long call position shall devolve into long position in the underlying Futures
contract
• long put position shall devolve into short position in the underlying Futures
contract
• short call position shall devolve into short position in the underlying Futures
contract
• short put position shall devolve into long position in the underlying Futures
contract

All such devolved futures positions shall be opened at the strike price of the
exercised options.
Initial Margin Initial Margin: The Exchange shall adopt appropriate initial margin model and
parameters that are risk-based and generate margin requirements sufficient to
cover potential future exposure to participants/clients.

The initial margin shall be imposed at the level of portfolio of individual client
comprising of his positions in futures and options contracts on each commodity.
Margins shall be adequate to cover 99% VaR (Value at Risk) and Margin Period
of Risk (MPOR) shall be at least two days.

For buyer of the option, buy premium shall be charged as margins and blocked
from the collaterals.

On computation of settlement obligation at the end of day, the premium blocked

shall be released and collected as pay-in as per process notified.

The Exchange shall levy appropriate Short Option Minimum Margin (SOMM)
for sellers/ writers of the option contracts. The Exchange shall fix prudent
volatility scan range based on the volatility in the price of the underlying
commodity.
Other Margins Extreme loss margin: Extreme loss margin is the margin levied to cover the
losses that could occur outside the coverage of VaR margin.

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Calendar spread charge: The calendar spread margin shall be calculated on
the basis of delta of the portfolio of futures and options. A calendar spread
margin of 25% on each leg of the positions shall be charged.

Net Option Value : Net option value is computed as the difference between the
long option positions and the short option positions, valued at the last available
options price and shall be updated intraday at the current market value of the
relevant option contracts at the time of generation of risk parameters. Thus, the
mark to market gains and losses would not be settled in cash for options
positions but it shall be adjusted against the margins/collaterals of the client.

Margining at client level: Exchanges shall impose initial margins at the level of
portfolio of individual client comprising of his positions in futures and options
contracts on each commodity.

Other margins: Other margins like additional margins and special margins shall
be applicable as and when they are levied by the Exchange

Pre Expiry margin: Pre expiry margin on options shall be levied at 1/3 * Futures
margin % * Underlying Futures price * weightage (if any) for three days before
expiry of the option contract. Pre expiry margin on options shall be levied on
options buyers (holders) and options sellers (writers).

The pre-expiry margin on options shall be apart from other margins like Initial
margin, additional margins, spread margins etc.

Pre-expiry margins shall not be included in standard client margin reporting and
hence no penalty shall be levied on short collection/non-collection of the same
by the CMs from their clients.

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Module 5 : Instruments Available for Trading
In recent years, derivatives have become increasingly popular due to their applications for hedging,
speculation and arbitrage. Before we study about the applications of commodity derivatives, we will have
a look at some basic derivative products. While futures and options are now actively traded on many
Exchanges, forward contracts are popular on the OTC market. In this chapter, we shall study in detail these
three derivative contracts. At present, only commodity futures trade on the NCDEX.

5.1 Forward Contracts

A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of
the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain
specified future date for a certain specified price. The other party assumes a short position and agrees to
sell the asset on the same date for the same price. Other contract details like delivery date, price and
quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded
outside the exchanges.

The salient features of forward contracts are:

 They are bilateral contracts and hence exposed to counterparty risk.

 Each contract is custom designed, and hence is unique in terms of contract size, expiration date
and the asset type and quality.
 The contract price is generally not available in public domain.
 On the expiration date, the contract has to be settled by delivery of the asset.
 If the party wishes to reverse the contract, it has to compulsorily go to the same counterparty, which
often results in high prices being charged.

However, forward contracts in certain markets have become very standardized, as in the case of foreign
exchange, thereby reducing transaction costs and increasing transactions volume. This process of
standardization reaches its limit in the organized futures market.

Forward contracts are very useful in hedging and speculation. The classic hedging application would be
that of an exporter who expects to receive payment in dollars three months later. He is exposed to the risk
of exchange rate fluctuations. By using the currency forward market to sell dollars forward, he can lock on
to a rate today and reduce his uncertainty. Similarly an importer who is required to make a payment in
dollars two months hence can reduce his exposure to exchange rate fluctuations by buying dollars forward.

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If a speculator has information or analysis, which forecasts an upturn in a price, then he can go long on the
forward market instead of the cash market. The speculator would go long on the forward, wait for the price
to rise, and then take a reversing transaction to book profits.

5.1.1 Limitations of Forward Markets

Forward markets world-wide are afflicted by several problems:

 Lack of centralization of trading,

 Illiquidity and
 Counterparty risk

In the first two of these, the basic problem is that of too much flexibility and generality. The forward market
is like a real estate market in that any two consenting adults can form contracts against each other. This
often makes them design terms of the deal which are very convenient in that specific situation, but makes
the contracts non-tradable.

Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the
two sides to the transaction declares bankruptcy, the other suffers. Even when forward markets trade
standardized contracts, and hence avoid the problem of illiquidity, still the counterparty risk remains a very
serious issue.

5.2 Futures Contract

Futures markets were designed to solve the problems that exist in forward markets. A futures contract is
an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price.

But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate
liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a
standardized contract with standard underlying instrument, a standard quantity and quality of the underlying
instrument that can be delivered, (or which can be used for reference purposes in settlement) and a
standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an
equal and opposite transaction.

The main standardized items in a futures contract are:

 Quantity of the underlying

 Quality of the underlying
 The date and the month of delivery
 The units of price quotation and minimum price change

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  Delivery center

Box 5.2: The first financial futures market

Merton Miller, the 1990 Nobel laureate had said that "financial futures represent the most significant
financial innovation of the last twenty years." The first exchange that traded financial derivatives was
launched in Chicago in the year 1972. A division of the Chicago Mercantile Exchange, it was called
the International Monetary Market (IMM) and traded currency futures. The brain behind this was a
man called Leo Melamed, acknowledged as the "father of financial futures" who was then the
Chairman of the Chicago Mercantile Exchange. Before IMM opened in 1972, the Chicago Mercantile
Exchange sold contracts whose value was counted in millions. By 1990, the underlying value of all
contracts traded at the Chicago Mercantile Exchange totaled 50 trillion dollars.

These currency futures paved the way for the successful marketing of a dizzying array of similar
products at the Chicago Mercantile Exchange, the Chicago Board of Trade, and the Chicago Board
Options Exchange. By the 1990s, these exchanges were trading futures and options on everything from
Asian and American stock indexes to interest-rate swaps, and their success transformed Chicago
almost overnight into the risk-transfer capital of the world.

5.2.1 Distinction between Futures and Forward Contracts

Forward contracts are often confused with futures contracts. The confusion is primarily because both serve
essentially the same economic functions of allocating risk in the presence of future price uncertainty.
However, futures are a significant improvement over the forward contracts as they eliminate counterparty
risk and offer more liquidity. Table 5.1 lists the distinction between the two.

Table 5.1 Distinction between futures and forwards

Futures Forwards

Trade on an organised exchange OTC in nature

Standardized contract terms Customised contract terms

More liquid Less liquid

Requires margin payments No margin payment

Follows daily settlement Settlement happens at end of period

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5.2.2 Futures Terminology

 Spot price: The price at which an asset trades in the spot market.

 Futures price: The price at which the futures contract trades in the futures market.

 Contract cycle: The period over which a contract trades. The commodity futures contracts on the
NCDEX have one month, two months, and three months etc. (not more than a year) expiry cycles.
Most of the agri commodities futures contracts of NCDEX expire on the 20th day of the delivery
month. Thus, a January expiration contract expires on the 20th of January and a February
expiration contract ceases to exist for trading after the 20th of February. If 20th happens to be a
holiday, the expiry date shall be the immediately preceding trading day of the Exchange, other than
a Saturday. New contracts for agri commodities are introduced on the 10th of the month.

 Expiry date: It is the date specified in the futures contract. This is the last day on which the contract
will be traded, at the end of which it will cease to exist.

 Delivery unit: The amount of asset that has to be delivered under one contract. For instance, the
delivery unit for futures on Soybean on the NCDEX is 10 MT. The delivery unit for the Gold futures
contract is 1 kg.

 Basis: Basis is the difference between the futures price and the spot price. There will be a different
basis for each delivery month for each contract. In a normal market, futures prices exceed spot
prices. Generally, for commodities basis is defined as spot price -futures price. However, for
financial assets the formula, future price -spot price, is commonly used.

 Cost of carry: The relationship between futures prices and spot prices can be summarized in terms
of what is known as the cost of carry. This measures the storage cost plus the interest that is paid
to finance the asset.

 Initial margin: The amount that must be deposited in the margin account at the time a futures
contract is first entered into is known as initial margin.

 Marking-to-market (MTM): In the futures market, at the end of each trading day, the margin account
is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is
called marking to market.

 Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the
balance in the margin account never becomes negative. If the balance in the margin account falls
below the maintenance margin, the investor receives a margin call and is expected to top up the
margin account to the initial margin level before trading commences on the next day.

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5.3 Option Contract

In this section, we look at another interesting derivative contract, namely options.

An option is an agreement between two parties - one of whom is the buyer and the other the seller. An
option gives the holder or buyer of the option the right, but not the obligation, to buy or sell an asset at a
known fixed price (called the exercise price) at a given point in the future. The seller in turn, has the
obligation (and not the right) to sell or buy an asset to the buyer of the option when called upon by the
buyer of the option contract.

Box 5.2: History of options

Although options have existed for a long time, they were traded OTC, without much knowledge of
valuation. The first trading in options began in Europe and the US as early as the seventeenth century. It
was only in the early 1900s that a group of firms set up what was known as the put and call Brokers
and Dealers Association with the aim of providing a mechanism for bringing buyers and sellers
together. If someone wanted to buy an option, he or she would contact one of the member firms. The
firm would then attempt to find a seller or writer of the option either from its own clients or those of
other member firms. If no seller could be found, the firm would undertake to write the option itself
in return for a price.

This market however suffered from two deficiencies. First, there was no secondary market and
second, there was no mechanism to guarantee that the writer of the option would honour the contract.
In 1973, Black, Merton and Scholes invented the famed Black-Scholes formula. In April 1973, CBOE
was set up specifically for the purpose of trading options. The market for options developed so rapidly
that by early '80s, the number of shares underlying the option contract sold each day exceeded the
daily volume of shares traded on the NYSE. Since then, there has been no looking back.

For assuming this obligation, the seller charges a premium called the “option premium” from the buyer.
Unlike forwards and futures, the holder of the option is not obliged to exercise the contract. While no upfront
costs are incurred in entering into a forward or a future, an option requires the upfront payment of the option
premium.

There are two basic types of options: call options and put options.

 Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain
date for a certain price.

 Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain
date for a certain price.

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5.3.1 Option Terminology

 Commodity options: Commodity options are options with a commodity as the underlying. For
instance, a gold options contract would give the holder the right to buy or sell a specified quantity
of gold at the price specified in the contract.

 Stock options: Stock options are options on individual stocks. Options currently trade on over 500
stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified
price.

 Buyer/Holder/Owner of an option: The buyer of an option refers to the person who buys the option.
As a result, he gets the right (option) to buy or sell the underlying asset without the obligation to do
so. He pays premium to option seller/writer. In simple term, buyer pays the option premium to buy
the right but not the obligation to exercise his option on the seller/ writer

 Seller/Writer of an option: The writer of a call/ put option refers to the person who sells the option.
As a result, he acquires the obligation to buy or sell the underlying asset. He receives the option
premium from buyer for accepting the obligation. In simple term, seller receives the option premium
and is thereby obliged to sell/ buy the asset if the buyer exercises on him

 Long position: This refers to the buying of a security such as a stock, commodity, or currency, with
the expectation that the asset will rise in value. In the context of options, it refers to the buying of
an options contract.

 Short position: This refers to the sale of a borrowed security, commodity, or currency with the
expectation that the asset will fall in value. In the context of options, it is the sale (also known as
“writing”) of an options contract.

 Option price (or option premium): This is the amount paid by a buyer to the seller for acquiring the
right to buy or sell an underlying asset. Alternatively, it is the price received by the seller for
surrendering his rights in an option contract. It is usually paid upfront - at the time of entering into
the option contract.

 Expiration date: The date specified in the options contract is known as the expiration date, the
exercise date, the strike date or the maturity.

 Spot rate: This refers to the rate at which an underlying asset is quoted in the spot market.

 Exchange rate: This refers to the forward exchange rate that is to be used if the strike price is
expressed in a foreign currency.

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 Exercise price: The price at which the option holder may buy or sell the underlying security, as
defined in the terms of contract. A “call” holder may exercise to buy the underlying asset or the
“put” holder may exercise to sell the underlying asset.

 Strike price: The price specified in the options contract is known as the strike price or the exercise
price.

 American options: American options are options that can be exercised at any time up to the
expiration date. Most exchange-traded options are American.

 European options: European options are options that can be exercised only on the expiration date
itself.

 In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash
flow to the holder if it were exercised immediately. A call option on the index is said to be in-the-
money when the current index stands at a level higher than the strike price (i.e. spot price > strike
price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case
of a put, the put is ITM if the index is below the strike price.

 At-the-money option: An at-the-money (ATM) This option is one, which leads to nil or zero cash
flow to its holder. This would be the situation where the price of the underlying asset equals the
option’s exercise price. (i.e. spot price = strike price).

 Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a

negative cash flow if it were exercised immediately. A call option on the index is out-of-the-money
when the current index stands at a level which is less than the strike price (i.e. spot price < strike
price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case
of a put, the put is OTM if the index is above the strike price.

 Intrinsic value of an option: The option premium can be broken down into two components - intrinsic
value and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the
call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max [0;
(St - K)] which means the intrinsic value of a call is the greater of 0 or (St - K). Similarly, the intrinsic
value of a put is Max[0;K - St],i.e. the greater of 0 or (K - St). K is the strike price and St is the spot
price.

 Time value of an option: The time value of an option is the difference between its premium and its
intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time
value. Usually, the maximum time value exists when the option is ATM. The longer the time to
expiration, the greater is an option's time value, all else equal. At expiration, an option should have
no time value.

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  There are some exotic options like Bermuda Options (is a type of exotic option that can only be
exercised on predetermined dates, often on one day each month), look back options (are a type of
exotic option with path dependency, among many other kind of options. The payoff depends on the
optimal underlying asset's price occurring over the life of the option. The option allows the holder
to "look back" over time to determine the payoff. etc.).

Box 5.3: Use of options in the seventeenth-century

Options made their first major mark in financial history during the tulip-bulb mania in seventeenth-
century Holland. It was one of the most spectacular get rich quick binges in history. The first tulip was
brought into Holland by a botany professor from Vienna. Over a decade, the tulip became the most
popular and expensive item in Dutch gardens. The more popular they became, the more Tulip bulb
prices began rising. That was when options came into the picture. They were initially used for hedging.
By purchasing a call option on tulip bulbs, a dealer who was committed to a sales contract could be
assured of obtaining a fixed number of bulbs for a set price. Similarly, tulip-bulb growers could assure
themselves of selling their bulbs at a set price by purchasing put options. Later, however, options were
increasingly used by speculators who found that call options were an effective vehicle for obtaining
maximum possible gains on investment. As long as tulip prices continued to skyrocket, a call buyer
would realize returns far in excess of those that could be obtained by purchasing tulip bulbs
themselves. The writers of the put options also prospered as bulb prices spiralled since writers were
able to keep the premiums and the options were never exercised. The tulip-bulb market collapsed in
1636 and a lot of speculators lost huge sums of money. Hardest hit were put writers who were unable
to meet their commitments to purchase Tulip bulbs.

5.4 Basic Payoffs

A payoff is the likely profit/ loss that would accrue to a market participant with change in the price of the
underlying asset. This is generally depicted in the form of payoff diagrams which show the price of the
underlying asset on the X-axis and the profits/ losses on the Y-axis. In this section, we shall take a look at
the payoffs for buyers and sellers of futures and options. But first we look at the basic payoff for the buyer
or seller of an asset. The asset could be a commodity like gold or corainder or jeera or chilli, or it could be
a financial asset like a stock or an index.

5.4.1 Payoff for Buyer: Long Position

In this basic position, an investor buys the underlying asset, jeera for instance, for Rs. 18,000 per 100 KGs,
and sells it at a future date at an unknown price, St. Once it is purchased, the investor is said to be 'long'
the asset. Figure 5.1 shows the payoff for a long position on jeera. In the above example, the investor has

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bought the contract for for Rs. 18,000 per 100 Kgs of jeera. When the investor decides to sell jeera, he
would have made a profit of Rs. 500 per 100 KGs of jeera if the prices have touched Rs. 18,500 per 100
KGs. On the other hand, if prices had fallen to Rs. 17,500 per 100 KGs, the investor would have made a
loss of Rs 500 per 100 KGs.

Figure 5.1 Payoff for buyer of Jeera

The figure shows the profits / losses from a long position on jeera. The investor bought jeera at Rs. 18000
per 100 KGS. If the price of jeera rises, he profits. If price of jeera falls, he loses.

5.4.2 Payoff for Seller: Short Position

In this basic position, an investor shorts the underlying asset, coriander for instance, for Rs. 6500 per
quintal, and buys it back at a future date at an unknown price, St. Once it is sold, the investor is said to be
'short' the asset. Figure 5.2 shows the payoff for a short position on coriander. In the above example, the
investor has sold the commodity (coriander) for Rs. 6500 per quintal. If prices increase and touch Rs. 7000
per quintal on the day when the investor offsets the position by buying the commodity, he stands to lose
Rs. 500 per quintal. On the other hand, if the prices fell to Rs. 6000 per quintal, the investor stands to gain
Rs. 500 per quintal.

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Figure 5.2 Payoff for a seller of coriander

The figure shows the profits / losses from a short position on coriander. The investor sold coriander at Rs.
6500 per quintal. If the price of coriander falls, he profits. If price of coriander rises, he loses.

5.5 Payoff for Futures

Futures contracts have linear payoff, just like the payoff of the underlying asset that we looked at earlier. If
the price of the underlying rises, the buyer makes profits. If the price of the underlying falls, the buyer makes
losses. The magnitude of profits or losses for a given upward or downward movement is the same. The
profits as well as losses for the buyer and the seller of a futures contract are unlimited. These linear payoffs
are fascinating as they can be combined with options and the underlying to generate various complex
payoffs.

5.5.1 Payoff for Buyer of Futures: Long Futures

The payoff for a person who buys a futures contract is similar to the payoff for a person who holds an asset.
He has a potentially unlimited upside as well as a potentially unlimited downside.

Take the case of a speculator who buys a two-month gold futures contract on the NCDEX when it sells for
Rs. 18000 per 10 gms. The underlying asset in this case is gold. When the prices of gold in the spot market
goes up, the futures price too moves up and the long futures position starts making profits. Similarly, when
the prices of gold in the spot market goes down, the futures prices too move down and the long futures
position starts making losses. Figure 5.3 shows the payoff diagram for the buyer of a gold futures contract.
In the above example, the investor enters into a two month futures contract at Rs. 18000 per 10 gms of
gold and holds the contract till expiry. On the expiry day, if the final settlement price is declared as Rs.
18500 per 10 gms, the investor will have made a profit of Rs. 500 per 10 gms through the term of the

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contract. On the other hand, if prices of gold have fallen, the final settlement price may be Rs. 17500 per
10 gms. In that event, the investor would have made a loss of Rs. 500 per 10 gms.

Figure 5.3 Payoff for a buyer of gold futures

The figure shows the profits / losses for a long futures position. The investor bought futures when gold
futures were trading at Rs. 18000 per 10 gms. If the price of the underlying gold goes up, the gold futures
price too would go up and his futures position starts making profit. If the price of gold falls, the futures price
falls too and his futures position starts showing losses.

5.5.2 Payoff for Seller of Futures: Short Futures

The payoff for a person who sells a futures contract is similar to the payoff for a person who shorts an
asset. He has a potentially unlimited upside as well as a potentially unlimited downside. Take the case of
a speculator who sells a two-month castor seed futures contract when the contract sells at Rs.6500 per
quintal. The underlying asset in this case is red castor seed. When the prices of castor seed move down,
the castor seed futures prices also move down and the short futures position starts making profits. When
the prices of castor seed move up, the castor seed futures price also moves up and the short futures
position starts making losses. Figure 5.4 shows the payoff diagram for the seller of a futures contract. In
the above example, the investor sells a castor seed futures contract for Rs. 6500 per quintal. If the prices
rise to Rs. 7000 per quintal on expiry date, the investor stands to make a loss of Rs. 500 per quintal at the
end of the term of the contract. If the prices fall to Rs. 6000 per quintal, the investor makes profit of Rs. 500
per quintal.

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Figure 5.4 Payoff for a seller of castor seed futures

The figure shows the profits / losses for a short futures position. The investor sold castor seed futures at
Rs. 6500 per quintal. If the price of the underlying red castor seed goes down, the futures price also falls,
and the short futures position starts making profit. If the price of the underlying red castor seed rises, the
futures too rise, and the short futures position starts showing losses.

5.6 Payoff for Options

The optionality characteristic of options results in a non-linear payoff for options. In simple words, it means
that the losses for the buyer of an option are limited, however the profits are potentially unlimited. The writer
of an option gets paid the premium. The payoff from the option written is exactly the opposite to that of the
option buyer. His profits are limited to the option premium, however his losses are potentially unlimited.
These non-linear payoffs are fascinating as they lend themselves to be used for generating various complex
payoffs using combinations of options and the underlying asset. We look here at the four basic payoffs.

5.6.1 Payoff for Buyer of Call Options: Long Call

A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option.
The profit/ loss that the buyer makes on the option depends on the spot price of the underlying. If upon
expiration, the spot price exceeds the strike price, he makes a profit. Higher the spot price, more is the
profit he makes. If the spot price of the underlying is less than the strike price, he makes loss. If he lets his
option expire un-exercised, his loss in this case is the premium he paid for buying the option. Figure 5.5
gives the payoff for the buyer of a three month call option on gold (often referred to as long call) with a
strike of Rs.17000 per 10 gms, bought at a premium of Rs.500. In the above example, the holder of the
option pays a premium of Rs. 500 and buys a call option to buy 10 gms of gold at Rs. 17000. In the case
of a European option which can be exercised only on expiry, if the price of gold stands at Rs. 18000 per

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10 gms at the expiry of the contract, then it makes sense for the holder of the option to exercise the option.
The investor will stand to gain Rs. 1000 per 10 gms of gold (Rs. 18000 market price at which the investor
sells 10 gms of gold less Rs. 17000 at which he bought the 10 gms on exercise of his option). The investor
will make a net profit of Rs. 500 per 10 gms of gold since he has already paid Rs. 500 to the writer of the
option as premium.

If on expiry, the price of gold stands between Rs. 17500 to Rs. 17000 per 10 gms of gold, it still makes
economic sense for the investor to exercise his option to buy gold at Rs. 17000 per 10 gms, since he can
recover a part of the premium paid to the writer of the option. If, for e.g., on expiry date, the price of gold
stands at Rs. 17250 per 10 gms of gold, he can exercise the option to buy the gold at Rs. 17000 per 10
gms and sell it in the spot market at Rs. 17250 per 10 gms. The profit made would be Rs. 250 per 10 gms.
The investor would have made a net loss of Rs. 250 considering that he has already paid a premium of Rs.
500 to buy the options contract. If the investor lets the option lapse without exercising it, this loss would go
up to Rs. 500, the full amount of the premium. If on the other hand, the price of 10 gms of gold has fallen
to less than Rs. 17000, then it makes sense for the investor to let the option lapse. In that event, the investor
has made a total loss of Rs. 500 per 10 gms of gold.

Figure 5.5 Payoff for buyer of call option on gold

The figure shows the profits / losses for the buyer of a three-month call option on gold at a strike of Rs.
17000 per 10 gms. As can be seen, as the prices of gold rise in the spot market, the call option becomes
in-the-money. If upon expiration, gold trades above the strike of Rs. 17000, the buyer would exercise his
option and get profit. The profits possible on this option are potentially unlimited. However, if the price of
gold falls below the strike of Rs. 17000, he lets the option expire. His losses are limited to the extent of the
premium he paid for buying the option.

5.6.2 Payoff for Writer of Call Options: Short Call

A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option.
For selling the option, the writer of the option charges a premium. The profit/ loss that the buyer makes on

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the option depends on the spot price of the underlying. Whatever is the buyer's profit is the seller's loss. If
upon expiration, the spot price exceeds the strike price, the buyer will exercise the option on the writer.
Hence, as the spot price increases, the writer of the option starts making losses. Higher the spot price,
more is the loss he makes. If upon expiration the spot price of the underlying is less than the strike price,
the buyer losses. If he lets his option expire un-exercised, the writer gets to keep the premium. Figure 5.6
gives the payoff for the writer of a three month call option on gold (often referred to as short call) with a
strike of Rs. 17000 per 10 gms, sold at a premium of Rs. 500. In the above example, the investor has
written an option in favour of the holder to make available to the holder of the option 10 gms of gold at Rs.
17000 . For writing the option, the investor earns Rs. 500. If the price of gold fall below Rs. 17000 per 10
gms of gold, then the holder of the option will let the option expire without exercising the option. In that
event, the writer of the option would have made a profit of Rs. 500 for having written an option which was
not exercised.

On the other hand, if the prices of gold rises above Rs. 17000 but below Rs. 17500 per 10 gms, then the
writer of the option will not profit from the entire Rs. 500 paid to him as premium. For eg, if the price of gold
rises to Rs. 17250 per 10 gm. He stands to make a profit of only Rs. 250.

If the price of gold rises above Rs. 17500, he stands to make a loss to the full amount of the premium. If
for e.g. the price on expiry stands at Rs. 18000 per 10 gms of gold, the option will be exercised. The writer
will have to sell 10 gms of gold at Rs. 17000 while the market price for the same commodity is Rs. 18000
per 10 gms. He thus makes a loss of Rs. 1000 per 10 gms of gold. Considering the fact that he has already
received Rs. 500 as premium for writing the contract, his net loss stands at Rs. 500.
Figure 5.6 Payoff for writer of call option on gold

The figure shows the profits / losses for the seller of a three-month call option on gold with a strike of Rs.
17000 per 10 gms. As the price of gold in the spot market rises, the call option becomes in-the-money and
the writer starts making losses. If upon expiration, gold price is above the strike of Rs. 17000, the buyer

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would exercise his option on the writer who would suffer a loss. The loss that can be incurred by the writer
of the option is potentially unlimited, whereas the maximum profit is limited to the extent of the up-front
option premium of Rs. 500 charged by him.

5.6.3 Payoff for Buyer of Put Options: Long Put

A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option.
The profit/ loss that the buyer makes on the option depends on the spot price of the underlying. If upon
expiration, the spot price is below the strike price, he makes a profit. Lower the spot price, more is the profit
he makes. If the spot price of the underlying is more than the strike price, he makes loss. If he lets his
option expire un-exercised, his loss in this case is the premium he paid for buying the option. Figure 5.7
gives the payoff for the buyer of a three month put option on cotton (often referred to as long put) with a
strike of Rs. 6000 per quintal, bought at a premium of Rs. 400. In the above example, the investor
purchases an option which gives her/him the right to sell cotton at Rs. 6000 per quintal. For the above
option, the investor has paid the writer of the option Rs. 400 upfront.

If the prices of cotton fall below Rs. 5600, the holder of the put option makes a profit by exercising his option
to sell at Rs. 6000 per quintal of cotton. Let us assume that at the expiry of this European put option, the
price of cotton stands at Rs. 5000 per quintal. In that event, the investor will make a profit of Rs. 1000 per
quintal of cotton as the market price for the same commodity is Rs. 5000 per quintal as versus the
contractual price of Rs. 6000 per quintal on exercise of the option. But the profit, net of the premium paid
to the writer of the option, will be Rs. 600 per quintal of cotton.

If the price of cotton stands between Rs. 5600 - Rs. 6000 per quintal, it still makes economic sense for the
investor to exercise his option. For eg. If the price of cotton stands at Rs. 5800 per quintal, the investor will
exercise his option and sell to the writer of the option the cotton at Rs. 6000 per quintal. He has made a
profit of only Rs. 200 per quintal from this transaction which does not cover the premium of Rs. 400.
However, the investor stands to make a net loss of Rs. 200.

On the other hand, if the prices of cotton rise above Rs. 6000, the holder of the option will let the option
expire as he can sell the cotton in the market for a better price.

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Figure 5.7 Payoff for buyer of put option on cotton

The figure shows the profits / losses for the buyer of a three-month put option on cotton. As can be seen,
as the price of cotton in the spot market falls, the put option becomes in-the- money. If at expiration, cotton
prices fall below the strike of Rs. 6000 per quintal, the buyer would exercise his option and get profit.
However, if spot price of cotton on the day of expiration of the contract is above the strike of Rs. 6000, he
lets the option expire. His losses are limited to the extent of the premium he paid for buying the option, Rs.
400 in this case.

5.6.4 Payoff for Writer of Put Options: Short Put

A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option.
For selling the option, the writer of the option charges a premium. The profit/loss that the buyer makes on
the option depends on the spot price of the underlying. Whatever is the buyer's profit is the seller's loss. If
upon expiration, the spot price happens to be below the strike price, the buyer will exercise the option on
the writer. If upon expiration the spot price of the underlying is more than the strike price, the buyer lets his
option expire un-exercised and the writer gets to keep the premium. Figure 5.8 gives the payoff for the
writer of a three month put option on cotton (often referred to as short put) with a strike of Rs. 6000 per
quintal, sold at a premium of Rs.400. In the above example, for a writer of a put option, the profit that he
makes is restricted to the premium of Rs. 400 that he receives from the holder of the option.

In case on exercise of option, the price of cotton stands at Rs. 5000 per quintal. The writer of the contract
will have to buy the cotton from the holder of the contract for Rs. 6000 while the market price of the same
commodity is Rs. 5000 per quintal. Thus, he makes a loss of Rs. 1000 per quintal. But the loss net of the
premium will be Rs. 600 since the writer of the option has already received Rs. 400 upfront as premium.

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In case on exercise, the price of cotton lies between Rs. 5600 and Rs. 6000, the investor may still exercise
his option. In that event, the profit made by the writer will have to be adjusted for the rise in price. For e.g.
if price for the quintal of cotton stood at Rs. 5800, then the writer would make a net profit of only Rs. 200.

In case on exercise, the price of cotton stands at Rs. 6000 per quintal, then the holder of the option will let
the option lapse. In this event, the writer of the option makes a profit of Rs. 400.

Figure 5.8 Payoff for writer of put option on cotton

The figure shows the profits / losses for the seller of a three-month put option on cotton. As the price of
cotton in the spot market falls, the put option becomes in-the-money and the writer starts making losses. If
upon expiration, cotton prices fall below the strike of Rs. 6000 per quintal, the buyer would exercise his
option on the writer who would suffer a loss to the extent of the difference between the strike price and spot
cotton-close. The profit that can be made by the writer of the option is limited to extent of the premium
received by him i.e. Rs. 400 whereas the losses are limited to the strike price since the worst that can
happen is that the price of the underlying asset falls to zero.

Table 5.2 Distinction between Futures and Options

Futures Options

Exchange traded, with novation Same as futures

Exchange defines the product Same as futures

Price is zero, strike price moves Strike price is fixed, price moves

Linear payoff Nonlinear payoff

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5.7 Using Futures Versus Using Options

An interesting question to ask at this stage is - when would one use options instead of futures? Options are
different from futures in several interesting senses. At a practical level, the option buyer faces an interesting
situation. He pays for the option in full at the time it is purchased. After this, he only has an upside. There
is no possibility of the options position generating any further losses to him (other than the funds already
paid for the option). This is different from futures, which is free to enter into, but can generate very large
losses. This characteristic makes options attractive to many occasional market participants, who cannot
put in the time to closely monitor their futures positions.

More generally, options offer "nonlinear payoffs" whereas futures only have "linear payoffs". By combining
futures and options, a wide variety of innovative and useful payoff structures can be created.

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Module 6 : Pricing Commodity Futures
The process of arriving at a price at which, a person buys and another sells a futures contract for a specific
expiration date is called price discovery. In an active futures market, the process of price discovery
continues from the market's opening until its close. The prices are freely and competitively derived. Future
prices are therefore considered to be superior to the administered prices or the prices that are determined
privately. Further, the low transaction costs and frequent trading encourages wide participation in futures
markets lessening the opportunity for control by a few buyers and sellers.

In an active futures market, the free flow of information is vital. Futures exchanges act as a focal point for
the collection and dissemination of statistics on supplies, transportation, storage, purchases, exports,
imports, currency values, interest rates and other pertinent information. Any significant change in this data
is immediately reflected in the trading pits as traders digest the new information and adjust their bids and
offers accordingly. As a result of this free flow of information, the market determines the best estimate of
today and tomorrow's prices and it is considered to be the reflection of the supply and demand for the
underlying commodity. Price discovery facilitates this free flow of information, which is vital to the effective
functioning of futures market.

In this chapter, we try to understand the pricing of commodity futures contracts and look at how the futures
price is related to the spot price of the underlying asset. We study the cost-of- carry model to understand
the dynamics of pricing that constitute the estimation of fair value of futures.

6.1 Investment Assets Versus Consumption Assets

When studying futures contracts, it is essential to distinguish between investment assets and consumption
assets. An investment asset is an asset that is held for investment purposes by most investors. Stocks and
bonds are examples of investment assets. Gold and silver are also examples of investment assets. Note
however that investment assets do not always have to be held exclusively for investment. As we know,
silver, for example, has a number of industrial uses. However, to classify as investment assets, these
assets do have to satisfy the requirement that they are held by a large number of investors solely for
investment. A consumption asset is an asset that is held primarily for consumption. It is not usually held for
investment. Examples of consumption assets are commodities such as copper and oil.

As we will learn, we can use arbitrage arguments to determine the futures prices of an investment asset
from its spot price and other observable market variables. For pricing consumption assets, we need to
review the arbitrage arguments a little differently. To begin with, we look at the cost-of-carry model and try
to understand the pricing of futures contracts on investment assets.

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6.2 The Cost of Carry Model

We use arbitrage arguments to arrive at the fair value of futures. For pricing purposes, we treat the forward
and the futures market as one and the same. A futures contract is nothing but a forward contract that is
exchange traded and that is settled at the end of each day. The buyer who needs an asset in the future
has the choice between buying the underlying asset today in the spot market and holding it, or buying it in
the forward market. If he buys it in the spot market today, it involves opportunity costs. He incurs the cash
outlay for buying the asset and he also incurs costs for storing it. If instead he buys the asset in the forward
market, he does not incur an initial outlay. However, the costs of holding the asset are now incurred by the
seller of the forward contract who charges the buyer a price that is higher than the price of the asset in the
spot market. This forms the basis for the cost-of-carry model where the price of the futures contract is
defined as:

F=S+C (6.1)

Where:

F Futures price

S Spot price

C Holding costs or carry costs

The fair value of a futures contract can also be expressed as:

F = S(1 + r)T (6.2)

where:

r Percent cost of financing

T Time till expiration

Whenever the futures price moves away from the fair value, there would be opportunities for arbitrage. If F

< S(1+r)T or F > S(1+r)T , arbitrage would exist. We know what are the spot and futures prices, but what
are the components of holding costs? The components of holding cost vary with contracts on different
assets. At times, the holding cost may even be negative. In the case of commodity futures, the holding cost
is the cost of financing plus cost of storage and insurance purchased. In the case of equity futures, the
holding cost is the cost of financing minus the dividends returns.

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Equation 6.2 uses the concept of discrete compounding, where interest rates are compounded at discrete
intervals, for example, annually or semiannually. Pricing of options and other complex derivative securities
requires the use of continuously compounded interest rates. Most books on derivatives use continuous
compounding for pricing futures too. When we use continuous compounding, equation 6.2 is expressed
as:

F=SerT (6.3)

where:

where:

r = Cost of financing (using continuously compounded interest rate)

T = Time till expiration; e = 2.71828

So far we were talking about pricing futures in general. To understand the pricing of commodity futures, let
us start with the simplest derivative contract - a forward contract. We use examples of forward contracts to
explain pricing concepts because forward contracts are easier to understand. However, the logic for pricing
a futures contract is exactly the same as the logic for pricing a forward contract. We begin with a forward
contract on an asset that provides the holder with no income and has no storage or other costs. Then we
introduce real world factors as they apply to investment commodities and later to consumption
commodities.

Consider a three-month forward contract on a stock that does not pay dividend. Assume that the price of
the underlying stock is Rs.40 and the three-month interest rate is 5% per annum. We consider the strategies
open to an arbitrager in two extreme situations.

 Suppose that the forward price is relatively high at Rs.43. An arbitrager can borrow Rs.40 from the
market at an interest rate of 5% per annum, buy one share in the spot market, and sell the stock in
the forward market at Rs.43. At the end of three months, the arbitrager delivers the share and
receives Rs.43. The sum of money required to pay off the loan is 40e0.05 x 0.25 = 40.50. By
following this strategy, the arbitrager locks in a profit of Rs.43.00 - Rs.40.50 = Rs.2.50 at the end
of the three month period.

 Suppose that the forward price is relatively low at Rs.39. An arbitrager can short one share for
Rs.40, invest the proceeds of the short sale at 5% per annum for three months, and take a long
position in a three-month forward contract. The proceeds of the short sale grow to 40e0.05 x 0.25
= 40.50 in three months. At the end of the three months, the arbitrager pays Rs.39, takes delivery
of the share under the terms of the forward contract and uses it to close his short position, in the
process making a net gain of Rs.1.50 at the end of three months.

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We see that if the forward price is greater than Rs.40.50, there exists arbitrage. Under such a situation,
arbitragers will sell the asset in the forward market, eventually driving the forward price down to Rs.40.50.
Similarly, if the forward price is less than Rs.40.50, there exists arbitrage. Arbitragers will buy the asset in
the forward market, eventually pushing the forward price up to Rs.40.50. At a forward price of Rs.40.50,
there will be no arbitrage. This is the fair value of the forward contract. The same arguments hold good for
a futures contract on an investment asset.

Now let us try to extend this logic to a futures contract on a commodity. Let us take the example of a futures
contract on a commodity and work out the price of the contract. The spot price of jeera is Rs.17000 per
100 KGs. If the cost of financing is 15% annually, what should be the futures price of 100 KGs of jeera one
month down the line ? Let us assume that we're on 1st January 2010. How would we compute the price of
a jeera futures contract expiring on 30th January? From the discussion above, we know that the futures
price is nothing but the spot price plus the cost-of-carry. Let us first try to work out the components of the
cost-of-carry model.

1. What is the spot price of jeera? The spot price of jeera, S= Rs.17000 per 100 KGs.

2. What is the cost of financing for a month? e0.15 x 30/ 365 .

3. What are the holding costs? Let us assume that the storage cost = 0.

In this case, the fair value of the futures works out to be = Rs.17,210.89

F = SerT = 17000*e0.15 x 30/365 = Rs.17,210.89

If the contract was for a three-month period i.e. expiring on 30th March, the cost of financing would increase
the futures price. Therefore, the fair value of futures would be F = 17000e0.15 x 90/365 = Rs.17,640.54.

6.2.1 Pricing Futures Contracts on Investment Commodities

In the example above, we saw how a futures contract on jeera could be priced using arbitrage arguments
and the cost-of-carry model. In the example we considered, the jeera contract was for 100 KGs of gold.
Hence, we ignored the storage costs. However, if the one-month contract was for a 10MT (10000 kgs) of
jeera instead of 100 KGs, then it would involve non-zero holding costs which would include storage and
insurance costs. The price of the futures contract would then be Rs.17,210.89 plus the holding costs.

Table 6.1 Indicative warehouse charges

Commodity Location Uni Warehou Assaying Sample Lot Assaying Rate

t se Size (Rs.)
Charges
for
per

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 MT/Per
Bale/ Per
Kg - Per
day (Rs.)
29 MM Cotton Akola Bal 1.1 100 Bales 2250
e
Barley Jaipur MT 4.2 20 MT 700
Castor Seed Bhabhar MT 5.5 10 MT 630
CHANA Akola MT 4.75 10 MT 400
Chana (In Cold Storage) Akola MT 7 10 MT 400
Coriander Baran MT 8.5 10 MT 1500
Coriander (In Cold Baran MT 11 10 MT 1500
Storage)
Cotton Seed Oil Cake Akola MT 4.05 50 MT 1800
Guar Gum Bikaner MT 5 10 MT 1500
Guar Seed Bikaner MT 4.5 10 MT 1500
Jeera Jodhpur MT 7 3 MT 1500
Jeera (In Cold Storage) Jodhpur MT 8.5 3 MT 1500
Kapas Rajkot MT 33.33 4 MT 2600
Maize – Feed/Industrial Gulabbag MT 5 50 MT 825
Grade h
Mustard Seed Alwar MT 4.2 10 MT 600
Pepper Kochi MT 12.5 10 MT 3700
Refined Soy Oil Indore MT 4.5 10 MT 1815
Soy Bean Akola MT 4 30 mt 1000
Sugar (M & S Grade) Delhi MT 4.5 50 MT 1600
Turmeric Basmat MT 7 10 MT 2600
Turmeric (In Cold Nizamab MT 12 10 MT 2600
Storage) ad
Wheat Baran MT 4 50 MT 600

Note: Detailed list available on the Exchange website

Table 6.1 gives the indicative warehouse charges for accredited warehouses/ vaults that functions as
delivery centres for contracts that trade on the NCDEX. Warehouse charges include a fixed charge per
deposit of commodity into the warehouse, and per unit per week charge. The per unit charges include
storage costs and insurance charges.

We saw that in the absence of storage costs, the futures price of a commodity that is an investment asset
is given by F = SerT. Storage costs add to the cost of carry. If U is the present value of all the storage costs
that will be incurred during the life of a futures contract, it follows that the futures price will be equal to

F = (S + U)erT (6.4)

where

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r = Cost of financing (annualised)

T = Time till expiration

U Present value of all storage costs

For ease of understanding, let us consider a one-year futures contract on gold. Suppose the fixed charge
(assaying rate) is Rs.1500 per deposit and the variable storage costs are Rs.490 per week (Rs.7 * 10* &
days) , it costs Rs.26,980 to store 10 MT of jeera for a year (52 weeks). Assume that the payment is made
at the beginning of the year. Assume further that the spot jeera price is Rs.17000 per 100 KGs and the
risk-free rate is 7% per annum. What would the price of one year Jeera futures be if the delivery unit is one
kg?

F = (S + U)erT

= (1,700,000 + 1,500 + 26,980) e0.07 x 1

= (1,728,480) e0.07 x 1

= 1,854,659

Box 6.1: The market crash of October 19. 1987

Under normal market conditions, F, the futures price is very close to S(1 + r)T. However,
on October 19,1987, the US market saw a breakdown in this classic relationship between
spot and futures prices. It was the day the markets fell by over 20% and the volume of
shares traded on the New York Stock Exchange far exceeded all previous records. For
most of the day, futures traded at significant discount to the underlying index. This was
largely because delays in processing orders to sell equity made index arbitrage too
risky. On the next day, October 20,1987, the New York Stock Exchange placed temporary
restrictions on the way in which program trading could be done. The result was that the
breakdown of the traditional linkages between stock indexes and stock futures
continued. At one point, the futures price for the December contract was 18% less than
the S&P 500 index which was the underlying index for these futures contracts! However,
the highlight of the whole episode was the fact.that inspite of huge losses, there were
no defaults by futures traders. It was the ultimate test of the efficiency of the margining
system in the futures market.

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We see that the one-year futures price of a kg of jeera would be Rs.1,854,659.04. Now let us consider a
three-month futures contract on jeera. We make the same assumptions.

The fixed charge is Rs.1500 per deposit and the variable storage costs are Rs.490 per week. It costs
Rs.6370 to store 10 MT of jeera for three months (13 weeks). Assume that the storage costs are paid at
the time of deposit. Assume further that the spot gold price is Rs.17000 per 100 KGs and the risk-free rate
is 7% per annum. What would the price of three month jeera futures if the delivery unit is one kg?

F = (S + U)erT

= (1700000 + 1500 + 6370)e0.07 x 0.25

= 17,38,021

We see that the three-month futures price of a 100 KGs of jeera would be Rs.17,38,021

6.2.2 Pricing Futures Contracts on Consumption

Commodities

We used the arbitrage argument to price futures on investment commodities. For commodities that are
consumption commodities rather than investment assets, the arbitrage arguments used to determine
futures prices need to be reviewed carefully. Suppose we have

F > (S + U)erT (6.5)

To take advantage of this opportunity, an arbitrager can implement the following strategy:

 Borrow an amount S+U at the risk-free interest rate and use it to purchase one unit of the
commodity and pay storage costs.

 Short a forward contract on one unit of the commodity.

If we regard the futures contract as a forward contract, this strategy leads to a profit of F-(S+U)erT at the
expiration of the futures contract. As arbitragers exploit this opportunity, the spot price will increase and the
futures price will decrease until Equation 6.5 does not hold good.

Suppose next that

F < (S + U)erT (6.6)

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In case of investment assets such as gold and silver, many investors hold the commodity purely for
investment. When they observe the inequality in equation 6.6, they will find it profitable to trade in the
following manner:

 Sell the commodity, save the storage costs, and invest the proceeds at the risk-free interest rate.

 Take a long position in a forward contract.

This would result in a profit at maturity of (S + U)erT - F relative to the position that the investors would have
been in had they held the underlying commodity. As arbitragers exploit this opportunity, the spot price will
decrease and the futures price will increase until equation 6.6 does not hold good. This means that for
investment assets, equation 6.4 holds good. However, for commodities like cotton or wheat that are held
for consumption purpose, this argument cannot be used. Individuals and companies, who keep such a
commodity in inventory, do so, because of its consumption value - not because of its value as an
investment. They are reluctant to sell these commodities and buy forward or futures contracts because
these contracts cannot be consumed. Therefore, there is unlikely to be arbitrage when equation 6.6 holds
good. In short, for a consumption commodity therefore,

F <= (S + U)erT (6.7)

That is the futures price is less than or equal to the spot price plus the cost of carry.

6.3 The Futures Basis

The cost-of-carry model explicitly defines the relationship between the futures price and the related spot
price. The difference between the spot price and the futures price is called the basis. We see that as a
futures contract nears expiration, the basis reduces to zero. This means that there is a convergence of the
futures price to the price of the underlying asset. This happens because if the futures price is above the
spot price during the delivery period it gives rise to a clear arbitrage opportunity for traders. In case of such
arbitrage the trader can short his futures contract, buy the asset from the spot market and make the

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delivery. This will lead to a profit equal to the difference between the futures price and spot price. As traders
start exploiting this arbitrage opportunity the demand for the contract will increase and futures prices will
fall leading to the convergence of the future price with the spot price.

If the futures price is below the spot price during the delivery period all parties interested in buying the asset
will take a long position. The trader would buy the contract and sell the asset in the spot market making a
profit equal to the difference between the future price and the spot price. As more traders take a long
position the demand for the particular asset would increase and the futures price would rise nullifying the
arbitrage opportunity.

Nuances

 As the date of expiration comes near, the basis reduces - there is a convergence of the futures
price towards the spot price. On the date of expiration, the basis is zero. If it is not, then there is an
arbitrage opportunity. Arbitrage opportunities can also arise when the basis (difference between
spot and futures price) or the spreads (difference between prices of two futures contracts) during
the life of a contract are incorrect. At a later stage, we shall look at how these arbitrage opportunities
can be exploited.

 There is nothing but cost of carry related arbitrage that drives the behaviour of the futures price in
the case of investment assets. In the case of consumption assets, we need to factor in the benefit
provided by holding the physical commodity.

 Transactions costs are very important in the business of arbitrage.

Note: The pricing models discussed in this chapter give an approximate idea about the true futures price.
However, the price observed in the market is the outcome of the price-discovery mechanism (demand-
supply principle) and may differ from the so-called true price.

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Module 7 : Using Commodity Futures
For a market to succeed, it must have all three kinds of participants - hedgers, speculators and arbitragers.
The confluence of these participants ensures liquidity and efficient price discovery in the market.
Commodity markets give opportunity for all three kinds of participants. In this chapter, we look at the use
of commodity derivatives for hedging, speculation and arbitrage.

7.1 Hedging

Many participants in the commodity futures market are hedgers. They use the futures market to reduce a
particular risk that they face. This risk might relate to the price of wheat or oil or any other commodity that
the person deals in. The classic hedging example is that of wheat farmer who wants to hedge the risk of
fluctuations in the price of wheat around the time that his crop is ready for harvesting. By selling his crop
forward, he obtains a hedge by locking in to a predetermined price. Hedging does not necessarily improve
the financial outcome; What it does however is, that it makes the outcome more certain. Hedgers could be
government institutions, private corporations like financial institutions, trading companies and even other
participants in the value chain, for instance farmers, extractors, millers, processors etc., who are influenced
by the commodity prices.

7.1.1 Basic Principles of Hedging

When an individual or a company decides to use the futures markets to hedge a risk, the objective is to
take a position that neutralizes the risk as much as possible. Take the case of a company that knows that
it will gain Rs.1,00,000 for each 1 rupee increase in the price of a commodity over the next three months
and will lose Rs.1,00,000 for each 1 rupee decrease in the price of a commodity over the same period. To
hedge, the company should take a short futures position that is designed to offset this risk. The futures
position should lead to a loss of Rs.1,00,000 for each 1 rupee increase in the price of the commodity over
the next three months and a gain of Rs.1,00,000 for each 1 rupee decrease in the price during this period.
If the price of the commodity goes down, the gain on the futures position offsets the loss on the commodity.
If the price of the commodity goes up, the loss on the futures position is offset by the gain on the commodity.

There are basically two kinds of hedges that can be taken. A company that wants to sell an asset at a
particular time in the future can hedge by taking short futures position. This is called a short hedge.
Similarly, a company that knows that it is due to buy an asset in the future can hedge by taking long futures
position. This is known as long hedge. We will study these two hedges in detail.

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7.1.2 Short Hedge

A short hedge is a hedge that requires a short position in futures contracts. As we said, a short hedge is
appropriate when the hedger already owns the asset, or is likely to own the asset and expects to sell it at
some time in the future. For example, a short hedge could be used by a cotton farmer who expects the
cotton crop to be ready for sale in the next two months. A short hedge can also be used when the asset is
not owned at the moment but is likely to be owned in the future. For example, an exporter who knows that
he or she will receive a dollar payment three months later. He makes a gain if the dollar increases in value
relative to the rupee and makes a loss if the dollar decreases in value relative to the rupee. A short futures
position will give him the hedge he desires.

Let us look at a more detailed example to illustrate a short hedge. We assume that today is the 15th of
January and that a refined soy oil producer has just negotiated a contract to sell 10,000 Kgs of soy oil. It
has been agreed that the price that will apply in the contract is the market price on the 15th April. The oil
producer is therefore in a position where he will gain Rs.10000 for each 1 rupee increase in the price of oil
over the next three months and lose Rs.10000 for each one rupee decrease in the price of oil during this
period. Suppose the spot price for soy oil on January 15 is Rs.450 per 10 Kgs and the April soy oil futures
price on the NCDEX is Rs.465 per 10 Kgs. The producer can hedge his exposure by selling 10,000 Kgs
worth of April futures contracts (1 unit). If the oil producer’s closes his position on April 15, the effect of the
strategy would be to lock in a price close to Rs.465 per 10 Kgs. Figure 7.1 gives the payoff for a short
hedge. Let us look at how this works.

On April 15, the spot price can either be above Rs.465 or below Rs.465.

Figure 7.1 Payoff for buyer of a short hedge

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The figure shows the payoff for a soy oil producer who takes a short hedge (dotted line). Irrespective of
what the spot price of Soy Oil is three months later, by going in for a short hedge he locks on to a price of
Rs. 465 per 10 kgs.

Table 7.1 Refined Soy Oil Futures Contract Specification

Trading system NCDEX trading system

Trading hours Monday- Friday :9:00 AM to 09:00 PM

Unit of trading 10,000 kgs (10 MT)

Delivery unit 10,000 kgs (10 MT)

Quotation / base value Rs. per 10 kgs

Tick size 5 paise

Case 1: The spot price is Rs. 455 per 10 Kgs. The company realises Rs.4,55,000 under its sales contract.
Because April is the delivery month for the futures contract, the futures price on April 15 should be very
close to the spot price of Rs. 455 on that date. The company closes its short futures position at Rs. 455,
making a gain of Rs.465 - Rs.455 = Rs.10 per 10 Kgs, or Rs. 10,000 on its short futures position. The total
amount realized from both the futures position and the sales contract is therefore about Rs. 465 per 10
Kgs, Rs.4,65,000 in total.

Case 2: The spot price is Rs.475 per 10 Kgs. The company realises Rs.4,75,000 under its sales contract.
Because April is the delivery month for the futures contract, the futures price on April 15 should be very
close to the spot price of Rs.475 on that date. The company closes its short futures position at Rs. 475,
making a loss of Rs.475 - Rs.465 = Rs.10 per 10 Kgs, or Rs. 10,000 on its short futures position. The total
amount realized from both the futures position and the sales contract is therefore about Rs. 465 per 10
Kgs, Rs. 4,65,000 in total.

7.1.3 Long Hedge

Hedges that involve taking a long position in a futures contract are known as long hedges. A long hedge is
appropriate when a company knows it will have to purchase a certain asset in the future and wants to lock
in a price now.

Suppose that it is now January 15. A firm involved in industrial fabrication knows that it will require 300 kgs
of silver on April 15 to meet a certain contract. The spot price of silver is Rs.26800 per kg and the April
silver futures price is Rs. 27300 per kg. Table 7.2 gives the contract specification for silver. A unit of trading
is 30 kgs. The fabricator can hedge his position by taking a long position in ten units of futures on the
NCDEX. If the fabricator closes his position on April 15, the effect of the strategy would be to lock in a price

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close to Rs. 27300 per kg. Figure 7.2 gives the payoff for the buyer of a long hedge. Let us look at how this
works. On April 15, the spot price can either be above Rs. 27300 or below Rs. 27300 per kg.

Case 1: The spot price is Rs. 27800 per kg. The fabricator pays Rs. 83,40,000 to buy the silver from the
spot market. Because April is the delivery month for the futures contract, the futures price on April 15 should
be very close to the spot price of Rs. 27800 on that date. The company closes its long futures position at
Rs. 27800, making a gain of Rs.27800 - Rs.27300 = Rs.500 per kg, or Rs. 1,50,000 on its long futures
position. The effective cost of silver purchased works out to be about Rs. 27300 per Kg, or Rs.81,90,000
in total.

Case 2: The spot price is Rs. 26900 per Kg. The fabricator pays Rs.80,70,000 to buy the silver from the
spot market. Because April is the delivery month for the futures contract, the futures price on April 15 should
be very close to the spot price of Rs. 26900 on that date. The company closes its long futures position at
Rs. 26900, making a loss of Rs.27300 - Rs.26900 = Rs.400 per kg, or Rs.1,20,000 on its long futures
position. The effective cost of silver purchased works out to be about Rs. 27300 per Kg, or Rs.81,90,000
in total.

Figure 7.2 Payoff for buyer of a long hedge

The figure shows the payoff for an industrial fabricator who takes a long hedge. Irrespective of what the
spot price of silver is three months later, by going in for a long hedge he locks on to a price of Rs. 27300
per kg.

Note that the purpose of hedging is not to make profits, but to lock on to a price to be paid in the future
upfront. In the industrial fabricator example, since prices of silver rose in three months, on hind sight it
would seem that the company would have been better off buying the silver in January and holding it. But
this would involve incurring interest cost and warehousing costs. Besides, if the prices of silver fell in April,

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the company would have not only incurred interest and storage costs, but would also have ended up buying
silver at a much higher price.

In the examples above, we assume that the futures position is closed out in the delivery month. The hedge
has the same basic effect if delivery is allowed to happen. However, making or taking delivery can be a
costly process. In most cases, delivery is not made even when the hedger keeps the futures contract until
the delivery month. Hedgers with long positions usually avoid any possibility of having to take delivery by
closing out their positions before the delivery period.

7.1.4 Hedge Ratio

Hedge ratio is the ratio of the size of position taken in the futures contracts to the size of the exposure in
the underlying asset. So far in the examples we used, we assumed that the hedger would take exactly the
same amount of exposure in the futures contract as in the underlying asset. For example, if the hedgers
exposure in the underlying was to the extent of 11 bales of cotton, the futures contracts entered into were
exactly for this amount of cotton. We were assuming here that the optimal hedge ratio is one. In situations
where the underlying asset in which the hedger has an exposure is exactly the same as the asset
underlying the futures contract he uses, and the spot and futures market are perfectly correlated, a hedge
ratio of one could be assumed. In all other cases, a hedge ratio of one may not be optimal. Equation 7.1
gives the optimal hedge ratio, one that minimizes the variance of the hedger's position.

h = S/F (7.1)

where:

S: Standard deviation of S

F : Standard deviation of F

 : Coefficient of correlation between S and F

h: Hedge ratio

S: Change in spot price, S, during a period of time equal to the life of the hedge

F: Change in futures price, F, during a period of time equal to the life of the hedge

Let us consider an example. A company knows that it will require 11,000 bales of cotton in three months.
Suppose the standard deviation of the change in the price per quintal of cotton over a three-month period
is calculated as 0.032. The company chooses to hedge by buying futures contracts on cotton. The standard

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deviation of the change in the cotton futures price over a three-month period is 0.040 and the coefficient of
correlation between the change in price of cotton and the change in the cotton futures price is 0.8. The unit
of trading and the delivery unit for cotton on the NCDEX is 55 bales. What is the optimal hedge ratio? How
many cotton futures contracts should it buy?

If the hedge ratio were one, that is if the cotton spot and futures were perfectly correlated, as shown in
Equation 7.3, the hedger would have to buy 200 units (one unit of trading = 55 bales of cotton) to obtain a
hedge for the 11,000 bales of cotton it requires in three months.

Number of contracts =11, 000/55 (7.2)

N =1 = 200 (7.3)

However, in this case as shown in Equation 7.5, the hedge ratio works out to be 0.64. The company will
hence require to take a long position in 128 units of cotton futures to get an effective hedge (Equation 7.7).

Optimal hedge ratio = 0.8 x 0.032/0.040 (7.4)

h = 0.64 (7.5)

Number of contracts = 0.64 x 11,000/55 (7.6)

N =0.8 = 128 (7.7)

7.1.5 Advantages of Hedging

Besides the basic advantage of risk management, hedging also has other advantages:

A. Hedging stretches the marketing period. For example, a livestock feeder does not have to wait until
his cattle are ready to market before he can sell them. The futures market permits him to sell futures
contracts to establish the approximate sale price at any time between the time he buys his calves
for feeding and the time the fed cattle are ready to market, some four to six months later. He can
take advantage of good prices even though the cattle are not ready for market.

B. Hedging protects inventory values. For example, a merchandiser with a large, unsold inventory can
sell futures contracts that will protect the value of the inventory, even if the price of the commodity
drops.

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 C. Hedging permits forward pricing of products. For example, a jewellery manufacturer can determine
the cost for gold, silver or platinum by buying a futures contract, translate that to a price for the
finished products, and make forward sales to stores at firm prices. Having made the forward sales,
the manufacturer can use his capital to acquire only as much gold, silver, or platinum as may be
needed to make the products that will fill its orders.

7.1.6 Limitation of Hedging: Basis Risk

In the examples we used above, the hedges considered were perfect. The hedger was able to identify the
precise date in the future when an asset would be bought or sold. The hedger was then able to use the
futures contract to remove almost all the risk arising out of price of the asset on that date. In reality, hedging
is not quite this simple and straightforward. Hedging can only minimize the risk but cannot fully eliminate
it. The loss made during selling of an asset may not always be equal to the profits made by taking a short
futures position. This is because the value of the asset sold in the spot market and the value of the asset
underlying the future contract may not be the same. This is called the basis risk. In our examples, the
hedger was able to identify the precise date in the future when an asset would be bought or sold. The
hedger was then able to use the perfect futures contract to remove almost all the risk arising out of price of
the asset on that date. In reality, this may not always be possible for various reasons.

 The asset whose price is to be hedged may not be exactly the same as the asset underlying the
futures contract. For example, in India we have a large number of varieties of cotton being
cultivated. It is impractical for an Exchange to have futures contracts with all these varieties of
cotton as an underlying. The NCDEX has futures contracts on medium staple cotton. If a hedger
has an underlying asset that is exactly the same as the one that underlies the futures contract, he
would get a better hedge. But in many cases, farmers producing small staple cotton could use the
futures contract on medium staple cotton for hedging. While this would still provide the farmer with
a hedge, since the price of the farmers cotton and the price of the cotton underlying the futures
contract would be related. However, the hedge would not be perfect.

 The hedger may be uncertain as to the exact date when the asset will be bought or sold. Often the
hedge may require the futures contract to be closed out well before its expiration date. This could
result in an imperfect hedge.

 The expiration date of the hedge may be later than the delivery date of the futures contract. When
this happens, the hedger would be required to close out the futures contracts entered into and take
the same position in futures contracts with a later delivery date. This is called a rollover. Hedges
can be rolled forward many times. However, multiple rollovers could lead to short-term cash flow
problems.

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7.2 Speculation

An entity having an opinion on the price movements of a given commodity can speculate using the
commodity market. While the basics of speculation apply to any market, speculating in commodities is not
as simple as speculating on stocks in the financial market. For a speculator who thinks the shares of a
given company will rise, it is easy to buy the shares and hold them for whatever duration he wants to.
However, commodities are bulky products and come with all the costs and procedures of handling these
products. The commodities futures markets provide speculators with an easy mechanism to speculate on
the price of underlying commodities.

To trade commodity futures on the NCDEX, a customer must open a futures trading account with a
commodity derivatives broker. Buying futures simply involves putting in the margin money. This enables
futures traders to take a position in the underlying commodity without having to actually hold that
commodity. With the purchase of futures contract on a commodity, the holder essentially makes a legally
binding promise or obligation to buy the underlying security at some point in the future (the expiration date
of the contract).

We look here at how the commodity futures markets can be used for speculation.

7.2.1 Speculation: Bullish Commodity, Buy Futures

Take the case of a speculator who has a view on the direction of the price movements of gold. Perhaps he
knows that towards the end of the year due to festivals and the upcoming wedding season, the prices of
gold are likely to rise. He would like to trade based on this view. Gold trades for Rs. 16000 per 10 gms in
the spot market and he expects its price to go up in the next two-three months. How can he trade based
on this belief? In the absence of a deferral product, he would have to buy gold and hold on to it. Suppose
he buys a 1 kg of gold which costs him Rs. 16,00,000. Suppose further that his hunch proves correct and
three months later gold trades at Rs. 17000 per 10 grams. He makes a profit of Rs. 1,00,000 on an
investment of Rs. 16,00,000 for a period of three months. This works out to an annual return of about 25
percent. Today a speculator can take exactly the same position on gold by using gold futures contracts.
Let us see how this works. Gold trades at Rs. 16,000 per 10 gms and three-month gold futures trades at
Rs. 16,650 per 10 gms. Table 7.3 gives the contract specifications for gold futures. The unit of trading is 1
kg and the delivery unit for the gold futures contract on the NCDEX is 1 kg. He buys one kg of gold futures
which have a value of Rs. 16,65,000. Buying an asset in the futures market only require making margin
payments. To take this position, suppose he pays a margin of Rs. 1,66,500. Three months later gold trades
at Rs. 17,000 per 10 gms. As we know, on the day of expiration, the futures price converges to the spot
price (else there would be a risk-free arbitrage opportunity). He closes his long futures position at Rs.
17,000 in the process making a profit of Rs. 35,000 on an initial margin investment of Rs. 1,66,500. This

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works out to an annual return of 85 percent. Because of the leverage they provide, commodity futures form
an attractive tool for speculators.

7.2.2 Speculation: Bearish Commodity, Sell Futures

Commodity futures can also be used by a speculator who believes that there is likely to be excess supply
of a particular commodity in the near future and hence the prices are likely to see a fall. How can he trade
based on this opinion? In the absence of a deferral product, there wasn't much he could do to profit from
his opinion. Today all he needs to do is sell commodity futures.

Let us understand how this works. Simple arbitrage ensures that the price of a futures contract on a
commodity moves correspondingly with the price of the underlying commodity. If the commodity price rises,
so will the futures price. If the commodity price falls, so will the futures price. Now take the case of the
trader who expects to see a fall in the price of pepper. Suppose price of pepper is Rs.14000 per quintal
and he sells two pepper futures contract which is for delivery of 2 MT of pepper (1MT each). The value of
the contract is Rs. 2,80,000. He pays a small margin on the same. Three months later, if his hunch was
correct the price of pepper falls. So does the price of pepper futures. He close out his short futures position
at Rs.13000 per quintal i.e. Rs. 2,60,000 making a profit of Rs. 20,000.

7.3 Arbitrage

A central idea in modern economics is the law of one price. This states that in a competitive market, if two
assets are equivalent from the point of view of risk and return, they should sell at the same price. If the
price of the same asset is different in two markets, there will be operators who will buy in the market where
the asset sells cheap and sell in the market where it is costly. This activity termed as arbitrage, involves
the simultaneous purchase and sale of the same or essentially similar security in two different markets for
advantageously different prices. The buying cheap and selling expensive continues till prices in the two
markets reach an equilibrium. Hence, arbitrage helps to equalize prices and restore market efficiency.

F = (S + U)erT (7.8)

where:

r Cost of financing (annualised) T Time till expiration

U Present value of all storage costs

In the chapter on pricing, we discussed that the cost of carry ensures that futures prices stay in tune with
the spot prices of the underlying assets. Equation 7.8 gives the fair value of a futures contract on an
investment commodity. Whenever the futures price deviates substantially from its fair value, arbitrage

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opportunities arise. To capture mispricings that result in overpriced futures, the arbitrager must sell futures
and buy spot, whereas to capture mispricings that result in underpriced futures, the arbitrager must sell
spot and buy futures. In the case of investment commodities, mispricing would result in both, buying the
spot and holding it or selling the spot and investing the proceeds. However, in the case of consumption
assets which are held primarily for reasons of usage, even if there exists a mispricing, a person who holds
the underlying may not want to sell it to profit from the arbitrage.

7.3.1 Overpriced Commodity Futures: Buy Spot, Sell Futures

An arbitrager notices that gold futures seem overpriced. How can he cash in on this opportunity to earn risk
less profits? Say for instance, gold trades for Rs. 1600 per gram in the spot market. Three month gold
futures on the NCDEX trade at Rs.1685 per gram and seem overpriced. He could make risk less profit by
entering into the following set of transactions.

On day one, borrow Rs. 1,60,05,100 at 6% per annum to cover the cost of buying and holding gold. Buy
10 kgs of gold on the cash/ spot market at Rs. 1,60,00,000. Pay Rs.5100 (approx) as warehouse costs.

Simultaneously, sell 10 gold futures contract at Rs. 1,68,50,000. Take delivery of the gold purchased and
hold it for three months.

On the futures expiration date, the spot and the futures price converge. Now unwind the position.

Say gold closes at Rs. 1635 per gram in the spot market. Sell the gold for Rs. 1,63,50,000. Futures position
expires with profit of Rs. 5,00,000

From the Rs. 1,68,50,000 held in hand, return the borrowed amount plus interest of Rs. 1,62,46,986.

The result is a risk less profit of Rs. 6,04,014.

When does it make sense to enter into this arbitrage? If the cost of borrowing funds to buy the commodity
is less than the arbitrage profit possible, it makes sense to arbitrage. This is termed as cash-and-carry
arbitrage. Remember however, that exploiting an arbitrage opportunity involves trading on the spot and
futures market. In the real world, one has to build in the transactions costs into the arbitrage strategy.

7.3.2 Underpriced Commodity Futures: Buy Futures, Sell

Spot

An arbitrager notices that gold futures seem underpriced. How can he cash in on this opportunity to earn
risk less profits? Say for instance, gold trades for Rs.1600 per gram in the spot market. Three month gold

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futures on the NCDEX trade at Rs. 1620 per gram and seem underpriced. If he happens to hold gold, he
could make risk less profit by entering into the following set of transactions.

On day one, sell 10 kgs of gold in the spot market at Rs. 1,60,00,000.

Invest the Rs. 1,60,00,000 plus the Rs.5100 saved by way of warehouse costs for three months 6%.

Simultaneously, buy three-month gold futures on NCDEX at Rs.1,62,00,000.

Suppose the price of gold is Rs.1635 per gram. On the futures expiration date, the spot and the futures
price of gold converge. Now unwind the position.

The gold sales proceeds grow to Rs. 1,62,46,986

The futures position expires with a profit of Rs. 1,50,000 Buy back gold at Rs.1,63,50,000 on the spot
market.

The result is a risk less profit of Rs. 46,986

When the futures price of a commodity appears underpriced in relation to its spot price, an opportunity for
reverse cash and carry arbitrage arises. It is this arbitrage activity that ensures that the spot and futures
prices stay in line with the cost-of-carry. As we can see, exploiting arbitrage involves trading on the spot
market. As more and more players in the market develop the knowledge and skills to do cash-and-carry
and reverse cash-and-carry, we will see increased volumes and lower spreads in both the cash as well as
the derivatives market.

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Module 8 : Trading
In this chapter we shall take a brief look at the trading system for futures on NCDEX. However, the best
way to get a feel of the trading system is to actually watch the screen and observe how it operates.

8.1 Futures Trading System

The trading system on the NCDEX, provides a fully automated screen-based trading for futures on
commodities on a nationwide basis as well as an online monitoring and surveillance mechanism. It supports
an order driven market and provides complete transparency of trading operations.

Box 8.1: The open outcry system of trading

While most exchanges the world over are moving towards the electronic form of trading, some still follow
the open outcry method. Open outcry trading is a face-to-face and highly activate form of trading used
on the floors of the exchanges. In open outcry system the futures contracts are traded in pits. A pit is a
raised platform in octagonal shape with descending steps on the inside that permit buyers and sellers
to see each other. Normally only one type of contract is traded in each pit like a Eurodollar pit, Live
Cattle pit etc. Each side of the octagon forms a pie slice in the pit. All the traders dealing with a certain
delivery month trade in the same slice. The brokers, who work for institutions or the general public stand
on the edges of the pit so that they can easily see other traders and have easy access to their runners
who bring orders.

The trading process consists of an auction in which all bids and offers on each of the contracts are made
known to the public and everyone can see the market's best price. To place an order under this method,
the customer calls a broker, who time-stamps the order and prepares an office order ticket. The broker then
sends the order to a booth on the exchange floor called broker's floor booth. There, a floor order ticket
is prepared, and a clerk hand delivers the order to the floor trader for execution. In some cases, the floor
clerk may use hand signals to convey the order to floor traders. Large orders typically go directly from
the customer to the broker's floor booth. The floor trader, standing in a central location i.e. trading pit,
negotiates a price by shouting out the order to other floor traders, who bid on the order using hand
signals. Once filled, the order is recorded manually by both parties in the trade. At the end of each day,
the clearing house settles trades by ensuring that no discrepancy exists in the matched-trade
information.

The NCDEX system supports an order driven market, where orders match automatically. Order matching
is essentially on the basis of commodity, its price, time and quantity. All quantity fields are in units and price

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in rupees. The Exchange specifies the unit of trading and the delivery unit for futures contracts on various
commodities. The Exchange notifies the regular lot size and tick size for each of the contracts traded from
time to time. When any order enters the trading system, it is an active order. It tries to find a match on the
other side of the book. If it finds a match, a trade is generated. If it does not find a match, the order becomes
passive and gets queued in the respective outstanding order book in the system. Time stamping is done
for each trade and provides the possibility for a complete audit trail if required.

8.2 Entities in The Trading System

There are following entities in the trading system of NCDEX -

A. Trading cum Clearing Member (TCM) :

Trading cum Clearing Members can carry out the transactions (trading, clearing and settling) on
their own account and also on their clients' accounts. The Exchange assigns an ID to each TCM.
Each TCM can have more than one user. The number of users allowed for each trading member
is notified by the Exchange from time to time. Each user of a TCM must be registered with the
Exchange and is assigned an unique user ID. The unique TCM ID functions as a reference for all
orders/trades of different users. It is the responsibility of the TCM to maintain adequate control over
persons having access to the firm's User IDs.

B. Professional Clearing Member (PCM) :

These members can carry out the settlement and clearing for their clients who have traded through
TCMs or traded as TMs.

C. Trading Member (TM):

Member who can only trade through their account or on account of their clients and will however
clear their trade through PCMs/STCMs.

D. Strategic Trading cum Clearing Member (STCM):

This is up gradation from the TCM to STCM. Such member can trade on their own account, also
on account of their clients. They can clear and settle these trades and also clear and settle trades
of other trading members who are only allowed to trade and are not allowed to settle and clear.

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8.2.1 Guidelines for Allotment of Client Code

The trading members are recommended to follow guidelines outlined by the Exchange for allotment and
use of client codes at the time of order entry on the futures trading system:

 All clients trading through a member are to be registered clients at the member's back office.

 A unique client code is to be allotted for each client. The client code should be alphanumeric and
no special characters can be used.

 The same client should not be allotted multiple codes.

8.3 Commodity Futures Trading Cycle

NCDEX trades commodity futures contracts having one-month, two-month, three-month and more (not
more than 12 months) expiry cycles. Most of the futures contracts (mainly agri commodities contract) expire
on the 20th of the expiry month. Some contracts traded on the Exchange expire on the day other than 20th
of the month. New contracts for most of the commodities on NCDEX are introduced on 10th of every month.

8.4 Order Types and Trading Parameters

An electronic trading system allows the trading members to enter orders with various conditions attached
to them as per their requirements. These conditions are broadly divided into the following categories:

 Time conditions

 Price conditions

 Other conditions

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Several combinations of the above are possible thereby providing enormous flexibility to users. The order
types and conditions are summarized below. Of these, the order types available on the NCDEX system are
regular market order, limit order, stop loss order, immediate or cancel order, good till day order, good till
cancelled order, good till date order and spread order.

8.4.1 Time Conditions

• Good till day order: A day order, as the name suggests is an order which is valid for the day on
which it is entered. If the order is not executed during the day, the system cancels the order
automatically at the end of the day. Example: A trader wants to go long on February 1, 2019 in
refined soy oil on the commodity exchange. A day order is placed at Rs.660/ 10 kg. If the market
does not reach this price the order does not get filled even if the market touches Rs.661 and
closes. In other words, day order is for a specific price and if the order does not get filled that
day, one has to place the order again the next day.

• Good till cancelled (GTC): A GTC order remains in the system until the user cancels it.
Consequently, it spans trading days, if not traded on the day the order is entered. The maximum
number of days an order can remain in the system is notified by the Exchange from time to time
after which the order is automatically cancelled by the system. Each day counted is a calendar
day inclusive of holidays. The days counted are inclusive of the day on which the order is placed
and the order is cancelled from the system at the end of the day of the expiry period. Example:
A trader wants to go long on refined soy oil when the market touches Rs.650/ 10kg. Theoretically,
the order exists until it is filled up, even if it takes months for it to happen. The GTC order on the
NCDEX is cancelled at the end of a period of seven calendar days from the date of entering an
order or when the contract expires, whichever is earlier.

• Good till date (GTD): A GTD order allows the user to specify the date till which the order should
remain in the system if not executed. The maximum days allowed by the system are the same
as in GTC order. At the end of this day/ date, the order is cancelled from the system. Each day/
date counted are inclusive of the day/ date on which the order is placed and the order is cancelled
from the system at the end of the day/ date of the expiry period.

• Immediate or Cancel (IOC)/ Fill or kill order: An IOC order allows the user to buy or sell a contract
as soon as the order is released into the system, failing which the order is cancelled from the
system. Partial match is possible for the order, and the unmatched portion of the order is
cancelled immediately.

• All or none order: All or none order (AON) is a limit order, which is to be executed in its entirety,
or not at all.

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8.4.2 Price Condition

• Limit order: An order to buy or sell a stated amount of a commodity at a specified price, or at a
better price, if obtainable at the time of execution. The disadvantage is that the order may not
get filled at all if the price for that day does not reach the specified price.

• Stop-loss: A stop-loss order is an order, placed with the broker, to buy or sell a particular futures
contract at the market price if and when the price reaches a specified level. Futures traders often
use stop orders in an effort to limit the amount they might lose if the futures price moves against
their position. Stop orders are not executed until the price reaches the specified point. When the
price reaches that point the stop order becomes a market order. Most of the time, stop orders
are used to exit a trade. But, stop orders can be executed for buying/ selling positions too. A buy
stop order is initiated when one wants to buy a contract or go long and a sell stop order when
one wants to sell or go short. The order gets filled at the suggested stop order price or at a better
price.

Example: A trader has purchased Chana futures at Rs.4550 per quintal. He wishes to limit his loss to Rs.
50 a quintal. A stop order would then be placed to sell an offsetting contract if the price falls to Rs.4500 per
quintal. When the market touches this price, stop order gets executed and the trader would exit the market.

Box 8.2: After-hours electronic trading system

After-hours electronic trading first began in 1992 at CME (Chicago Mercantile Exchange). Called
Globex, this was introduced to meet the needs of an increasingly integrated global economy and to
have an access to the currency price protection around the clock. Typically electronic trading systems
are used in the open outcry exchanges after the day trading is over.

8.4.3 Other Conditions

• Market price: Market orders are orders for which no price is specified at the time the order is
entered (i.e. price is market price). For such orders, the system determines the price. Only the
position to be taken long/ short is stated. When this kind of order is placed, it gets executed
irrespective of the current market price of that particular commodity.

• Trigger price: Price at which an order gets triggered from the stop-loss book.

• Spread order: A simple spread order involves two positions, one long and one short. They are
taken in the same commodity with different months (calendar spread) or in closely related
commodities. Prices of the two futures contract therefore tend to go up and down together, and

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 gains on one side of the spread are offset by losses on the other. The spreaders goal is to profit
from a change in the difference between the two futures prices. The trader is virtually
unconcerned whether the entire price structure moves up or down, just so long as the futures
contract he bought goes up more (or down less) than the futures contract he sold.

8.4.4 Permitted Lot Size

The permitted trading lot size for the futures contracts and delivery lot size on individual commodities is
stipulated by the Exchange from time to time.

8.4.5 Tick Size for Contracts & Ticker Symbol

The tick size is the smallest price change that can occur for the trades on the Exchange. The tick size in
respect of futures contracts admitted to dealings on the NCDEX varies for all commodities. Above table
presents tick size (subject to change from time to time) for some of the commodity futures traded on
NCDEX.

A ticker symbol is a system of letters that are used to identify a stock, commodity, or mutual fund. NCDEX
generally uses a system of alphabetic/alphanumeric to identify its commodities uniquely. The symbol
indicates the commodity and it may indicate quality, quantity, and base centre of the commodity as well.
First six letters of the contract indicate the commodity and quality of the commodity that is being traded and
the last three letters, the base center (delivery location) of the commodity.

SYOREFIDR

• Commodity: SYO (Soy Oil)

• Quality: REF (Refined)

• Base Centre: IDR (Indore)

TMCFGRNZM indicates the commodity Turmeric finger and delivery center of Nizamabad. There are some
commodities for which two-three different futures contracts are available and hence the ticker symbol helps
in identifying these contracts easily. Following table shows some other ticker symbols used at NCDEX

Some Ticker Symbols used at NCDEX

Commodity Symbol

Barley BARLEYJPR

Castor seed CASTOR

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 Cotton Seed Oil Cake COCUDAKL

Crude palm oil CPO

Coriander DHANIYA

Guar Gum (5 MT) GUARGUM5

Guar Seed (10 MT) GUARSEED10

Jeera JEERAUNJHA
Soy Bean SYBEANIDR

Refined Soy Oil SYOREF

Rapeseed Mustard Seed RMSEED

Sugar SUGARM

Turmeric TMCFGRNZM

Wheat WHEATFAQ

Table 8.1 Commodity futures: Lot size and other parameters(for few commodities)

Commodity Trading Lot Price Unit Delivery Lot Tick Size

Sugar 10 MT Rs. per quintal 10 MT Rs. 1

Guar Gum 5 MT Rs. per quintal 5 MT Rs. 1

Pepper 1 MT Rs. per quintal 1 MT Rs. 5

Refined Soy Oil 10 MT Rs per 10 kg 10 MT 5 paise

Wheat 10 MT Rs. per quintal 10 MT Rs. 1

Note: Refer to website www.ncdex.com for latest specifications for all commodities traded at NCDEX.

8.4.6 Quantity Freeze

All orders placed by members have to be within the quantity specified by the Exchange in this regard. Any
order exceeding this specified quantity will not be executed but will lie pending with the Exchange as a
quantity freeze. Table 8.2 gives the quantity freeze for some select commodity contracts. In respect of
orders which have come under quantity freeze, the order gets deleted from the system at the end of the
day's trading session.

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8.4.7 Base Price

On introduction of new contracts, the base price is the previous days' closing price of the underlying
commodity in the prevailing spot markets. These spot prices are polled across multiple centers and a single
spot price is determined by the bootstrapping method. The base price of the contracts on all subsequent
trading days is the daily settlement price of the futures contracts on the previous trading day.

8.4.8 Price Ranges of Contracts

To control wide swings in prices, an intra-day price limit is fixed for commodity futures contract. The
maximum price movement during the day can be +/- x% of the previous day's settlement price for each
commodity. If the price hits the first intra-day price limit (at upper side or lower side), there will be a cooling
period of 15 minutes. Then price band is revised further and in case the price reach that revised level, no
trade is permitted during the day beyond the revised limit.

Take an example of Guar Seed- Daily price fluctuation limit is (+/-) 4% (3% +1%). If the trade hits the
prescribed first daily price limit of 3 %, there will be a cooling off period for 15 minutes. Trade will be allowed
during this cooling off period within the price band. Thereafter, the price band would be raised by (+/-) 1%
and trade will be resumed. If the price hits the revised price band (4%) during the day, trade will only be
allowed within the revised price band. No trade / order shall be permitted during the day beyond the limit
of (+/-) 4%.

In order to prevent erroneous order entry by trading members, operating price ranges on the NCDEX are
pre-decided for individual contracts from the base price. Presently, the price ranges for agricultural
commodities is (+/-) 4 % from the base price for the day, and upto (+/-) 9 % for non-agricultural commodities.
Orders, exceeding the range specified for a day's trade for the respective commodities are not executed.

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8.4.9 Trading Screen

8.4.10 Order Entry on the Trading System

The NCDEX trading system, NEXTRA has a set of function keys built into the trading front-end. These keys
have been provided to facilitate faster operation of the system and enable quicker trading on the system.
The function keys can be operated from the keyboard of the user. The set of function keys enable the
following:

Area Sr. No. Function Short Key

File A Login F9
B Logout F10
C Lock Application CTRL+W
D Refresh Broadcast CTRL+F5
E Change Password CTRL+SHIFT+F9
F Log Info F7

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 Market A Market Watch Profile F4
B Market Watch Group Setting CTRL+G
C Snap Quote F6
D Price Ladder CTRL+ALT+P
E VWAP STATISTICS CTRL+SHIFT+H
F NEXTRA NOTIFICATION CTRL+ALT+N
G Liquidity Schedule CTRL+SHIFT+Q

View Order and Trades A Order Entry

8.5 Margins for Trading in Futures

Margin is the deposit money that needs to be paid to buy or sell each contract. The margin required for a
futures contract is better described as performance bond or good faith money. The margin levels are set
by the Clearing House based on market volatility (market conditions) and change intraday.

The margin requirements for most futures range from 5% to 15% (subject to change from time to time) of
the value of the contract. In the futures market, a trader must maintain different types of margins such as
initial margin, additional margin, and extreme loss margin etc. These margins have been described in detail
in the section “Risk Management” in the module “Functioning and Regulation of Exchanges”.

Just as a trader is required to maintain a margin account with a broker, a clearing house member is required
to maintain collaterals/deposits with the clearing house against which the positions can be taken.

In the futures market, there are different types of margins that a trader has to maintain. We will discuss
them in more details when we talk about risk management in the next chapter. At this stage we look at the
types of margins as they apply on most futures exchanges:

• Initial margin: The amount that must be deposited by a customer at the time of entering into a
contract is called initial margin. This margin is meant to cover the potential loss in one day. The
margin is a mandatory requirement for parties who are entering into the contract. The exchange
levies initial margin on derivatives contracts using the concept of Value at Risk (VaR) or any
other concept as the Exchange may decide periodically. The margin is charged so as to cover
one-day loss that can be encountered on the position on 99.95% confidence-interval VaR
methodology.

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• Exposure & Mark-to-Market Margin: Exposure margin is charged taking into consideration the
back testing results of the VaR model. For all outstanding exposure in the market, the Exchange
also collects mark-to-market margin which are positions restated at the daily settlement prices
(DSP). At the end of each trading day, the margin account is adjusted to reflect the trader's gain
or loss. This is known as marking to market the account of each trader. All futures contracts are
settled daily reducing the credit exposure to one day's movement. Based on the settlement price,
the value of all positions is marked-to-market each day after the official close. i.e. the accounts
are either debited or credited based on how well the positions fared in that day's trading session.
If the account falls below the required margin level the clearing member needs to replenish the
account by giving additional funds or closing positions either partially/ fully. On the other hand, if
the position generates a gain, the funds can be withdrawn (those funds above the required initial
margin) or can be used to fund additional trades.

• Additional margin: In case of sudden higher than expected volatility, the Exchange calls for an
additional margin, which is a preemptive move to prevent potential default. This is imposed when
the Exchange/ regulator has view that that the markets have become too volatile and may result
in some adverse situation to the integrity of the market/ Exchange.

• Pre-expiry margin: This margin is charged as additional margin for most commodities expiring
during the current/near month contract. It is charged on a cumulative basis from typically 3 to 5
days prior to the expiry date (including the expiry date). This is done to ensure that only interested
parties remain in the market and speculators roll over their positions to subsequent months and
ensure better convergence of the futures and spot market prices.

• Delivery Margin: This margin is charged only in the case of positions materialising into delivery.
Members are informed about the delivery margin payable. Margins for delivery are to be paid the
day following expiry of contract.

• Special Margin : This margin is levied when there is more than 20% uni-directional movement in
the price from a pre-determined base and is typically related to the underlying spot price. The
base could be the closing price on the day of launch of the contract or the 90 days prior settlement
price. This is mentioned in the respective contract specification. Some contracts also have an
as-deemed-fit clause for levying of Special margins. It can also be levied by market regulator if
market exhibits excess volatility. If required by the regulator, it has to be settled by cash. This is
collected as extra margin over and above normal margin requirement.

• Margin for Calendar Spread positions: Calendar spread is defined as the purchase of one
delivery month of a given futures contract and simultaneous sale of another delivery month of
the same commodity by a client/ member. At NCDEX, for calendar spread positions, margins are
imposed as one half of the initial margin (inclusive of the exposure margin). Such benefit will be

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 given only of there is positive correlation in the prices of the months under consideration and the
far month contracts are sufficiently liquid. No benefit of calendar spread is given in the case of
additional and special margins. However, calendar spread positions in the far month contract are
considered as naked position three days before expiry of near month contract. Gradual reduction
of the spread position is done at the rate of 33.3% per day from 3 days prior to expiry.

Just as a trader is required to maintain a margin account with a broker, a clearing house member is required
to maintain collaterals/deposits with the clearing house against which the positions are allowed to be taken.

8.6 Charges

Members are liable to pay transaction charges for the trades done through the Exchange during the
previous month. The bill for the trades done during the previous month are raised in the succeeding month.
The important provisions at NCDEX are listed below:

8.6.1 Rate of Charges

The transaction charges are payable at the rate of Rs. 6 per lakh worth of trade done. This rate is charged
for average daily turnover upto Rs. 50 crores. Reduced rate is charged for increase in daily turnover based
on multiple slab. On highest slab incremental ADTV above 30 crores, Rs.3 per lakh is charged. This rate
is subject to change from time to time.

8.6.2 Due Date

The transaction charges are payable on the 10th day of every month, in respect of the trades done in the
previous month.

8.6.3 Collection Process

NCDEX has engaged the services of Bill Junction Payments Limited (BJPL) to collect the transaction
charges through Electronic Clearing System (ECS).

8.6.4 Registration with BJPL and their Services

Members must fill up the mandate form and submit the same to NCDEX. NCDEX then forwards the
mandate form to BJPL. BJPL sends the log in ID and password to the member’s mailing address as
mentioned in the registration form. The members can then log on to the website of BJPL and view the bill.
Advance e-mail intimation is also sent to the members.

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8.6.5 Adjustment against Advance Transaction Charges

Every member is required to pay Annual Advance Minimum Transaction Charges of Rs. 50,000/- latest by
April 30, every year. The said Annual Advance Minimum Transaction Charges are set off against the
transaction charges payable by the member for that particular year and any unadjusted balance at the end
of the year can be carried forward and adjusted against the Advance Transaction Charges payable for the
next year.

8.6.6 Penalty for Delayed Payments

If the transaction charges are not paid on or before the due date, penal interest is levied as specified by
the Exchange.

Finally, the futures market is a zero sum game i.e. the total number of long in any contract always equals
the total number of short in any contract. The total number of outstanding contracts (long/ short) at any
point in time is called the 'Open interest'. This Open interest figure is a good indicator of the liquidity in
every contract. Based on studies carried out in international Exchanges, it is found that open interest is
maximum in near month expiry contracts.

8.7 Hedge Limits

The Exchange permits higher client-level open interest (OI) limits (referred to as "Hedge Limits") to Hedgers
hedging the price risk of their current cash and expected future commodity requirement subject to their
satisfying certain conditions and producing documents as specified by the Exchange. We suggest readers
to visit NCDEX website >> Market Data >> Commodity wise hedge limit allocated to hedgers for updated
limits.

8.8 Broad SEBI Guidelines Issued In 2016 for

Hedging

In order to facilitate larger participation by genuine hedgers by providing them with necessary incentives
and with a view to deepen the commodity derivatives market, the exchanges stipulate a Hedge Policy for
granting hedge limits to their members and clients.

Present guideline while granting hedge limit Exemptions to their members and clients are:

• The hedge granted by the Exchanges to the bona fide hedgers is addition to the normal position
limit allowed to it. Such hedge limit is non-transferrable and can be utilized only by the Hedger
to whom the limit has been granted and not by anyone else

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 • This hedge limit granted for a commodity derivative is not available for the near month contracts
of the said commodity from the date of applicability of near month limit.

• Hedge limits for a commodity is determined on a case to case basis, depending on applicant’s
hedging requirement in the underlying physical market based upon his/its Export or import
commitments/ Stocks held/ Past track record of Production or Purchase or Sales/ Processing
capacity and other factors as the Exchanges may deem appropriate.

• The Exchanges undertake proper due diligence by verifying documentary evidence of the
underlying exposure and ensuring that the hedge limit granted is genuine and does not have the
potential to disturb the equilibrium of the market of that particular derivative contracts.

The hedge limit is also made available in respect of the short open position acquired by an entity for the
purpose of hedging against the stocks of commodities owned by it and,

• pledged with the Scheduled Commercial Banks/Co-operative Banks

• lying in any Government Entity’s warehouse/ WDRA Approved warehouses or

• lying in any other premises (warehouse, factory etc.), provided the premises is either owned by
the hedger or taken on lease by the hedger in its name and Exchange is satisfied such premises
are well equipped with quality control safeguards for storage of the relevant commodity.

And is subject to the production of the relevant Bank Certificate/Warehouse Receipt, as the case may be,
also subject to verification regarding ownership of the stocks etc., by the Exchange in accordance with
the procedure laid down by the Exchange in this regard.

At any point of time during the hedge period, hedging positions taken in derivatives contracts by hedger,
across multiple Exchanges/ Contracts, cannot exceed his/its actual/anticipated exposure in the physical
market, even if there is a usable hedge limit available as per allocation made by the Exchanges to the
hedger.

If under any circumstances a hedger is found availing hedge limit in contrary to the guideline framed by the
SEBI/Exchanges or submits false document or fails to inform Exchange timely about reduction of
underlying exposure based upon which it has been allocated hedge limit by Exchange, it shall be liable for
expulsion from membership/prohibition from trading as the case may be. Such action shall be without
prejudice to other disciplinary actions including penalties prescribed by Exchanges.

A Hedger having availed of benefit of hedge limits, should preserve relevant records for a period of
minimum three years for inspection by SEBI/Exchange.

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The hedge limit approved by an exchange is valid for a period as mentioned in the approval letter and such
hedge limit thereafter will stand cancelled automatically upon expiry of such period without any notice.

In view of above SEBI guidelines, detailed circular on Hedge Policy was issued by NCDEX on September
28,2016– Ref NCDEX/CLEARING-019/2016/246. Readers may refer to this circular wherein detailed
hedge policy note is available.

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Module 9 : Clearing and Settlement
Most futures contracts do not lead to the actual physical delivery of the underlying asset. The settlement is
done by closing out open positions, physical delivery or cash settlement. All these settlement functions are
taken care of by an entity called clearing house or clearing corporation. National Commodity Clearing
Limited (NCCL) undertakes clearing of trades executed on the NCDEX.

9.1 Clearing

Clearing of trades that take place on an Exchange happens through National Commodity Clearing Limited
(NCCL). NCCL is a wholly owned subsidiary of the National Commodity & Derivatives Exchange Ltd.
(NCDEX) and is responsible for clearing and settlement services of all trades executed on the exchange
and is committed to provide a robust and transparent risk management platform for the collective benefit
of the agri-ecosystem. A clearing house is a system by which Exchanges guarantee the faithful compliance
of all trade commitments undertaken on the trading floor or electronically over the electronic trading
systems. The main task of the clearing house is to keep track of all the transactions that take place during
a day so that the net position of each of its members can be calculated. It guarantees the performance of
the parties to each transaction. Typically it is responsible for the following:

• Effecting timely settlement.

• Trade registration and follow up.

• Control of the open interest.

• Financial clearing of the payment flow.

• Physical settlement (by delivery) or financial settlement (by price difference) of contracts.

• Administration of financial guarantees demanded by the participants.

9.1.1 Clearing House

Various trades undertaken by the customers in the Commodity Exchanges are processed through the
Clearing and Settlement system.

Clearing is the process by which trades in commodity futures contracts are processed, guaranteed, and
settled by a clearing house. A clearing house is the legal counterparty through which Commodity
Exchanges guarantee the faithful compliance and financial settlement of all trade commitments on the

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futures segment undertaken through the electronic trading platform. Therefore, the clearing house
becomes “the buyer to every seller and the seller to every buyer”. This is called “novation”.

Consequently, clearing substitutes the credit of the counterparty with that of the clearing house.

In India, the National Commodity Clearing Limited (NCCL) acts as the clearing house of trades that are
executed on NCDEX. In the case of NCDEX, there are two types of clearing members – Trading-cum-
Clearing Members (TCM and STCM) and Professional Clearing Members (PCM), who are responsible for
clearing and settlement of futures contracts traded on the Exchange. TCMs and STCMs clear and settle
their own trades and the trades of their constituents. PCMs clear and settle trades executed by other
members or their constituents.

Each clearing member deals with the clearing house, rather than dealing with many counterparties. At the
point where the trade becomes novated, the clearing guarantee becomes effective. In other words, the
clearing house guarantees the obligations of each clearing member.

9.1.2 Clearing Relationships

Market participants must have their trades carried (guaranteed) to the clearing house by a clearing member.
When the clearing house steps in, each clearing member enters into contracts with the clearing house, and
not with the other party. Each clearing member’s obligations/rights resulting from trades run to/from the
clearing house, not to/from other members. Clearing houses have a legal relationship only with entities that
they have admitted as clearing members. Clearing houses have no legal relationship with the customers
of their clearing members.

However, it is important to recognize that

• Clearing only minimizes credit risk; it does not eliminate it, and

• The clearing house has extreme interest in the member’s financial strength, but no competitive
interest in the direction of the member’s market positions.

9.1.3 Functions of a Clearing House

The main task of NCCL is to keep track of all the transactions that take place during a day so that the net
position of each of its members can be calculated. It guarantees the performance of the parties to each
transaction. It is responsible for:

• Effecting timely settlement

• Trade registration and follow up

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 • Control of the open interest

• Risk Management

• Publish Daily Settlement Price and Final Settlement Price

• Financial clearing of the payment flow

• Physical settlement (by delivery) or financial settlement (by price difference) of contracts

• Administration of financial guarantees of the participants

Overview of Clearing Process

The major processes involved in clearing are Position Management, Settlement Management and Financial
Management.

a) Position Management

This process essentially involves working out open positions and obligations of clearing members. This
position is considered for exposure and daily margin purposes.

The clearing house updates the positions that result from the trades. A particular trade can result in an
addition to an existing position, in a subtraction from an existing position or in the offset of an existing
position.

The open positions of PCMs are arrived at by aggregating the open positions of all the TMs clearing through
them, in contracts in which they have traded.

A TCM’s open position is arrived at by the summation of his proprietary and client’s open positions, in the
contracts in which they have traded. Client positions are netted at the level of the individual client and
grossed across all clients at the member level, without any set-offs between client and proprietary positions.
(Position limits have been discussed in detail in earlier)

Depending on the end-of-the-day open positions, the margin accounts for the clearing house members are
adjusted for gains and losses every day. Thus, depending on a day’s transactions and price movement,
the members need to add further funds or can withdraw funds from their margin accounts, at the end of the
day.

b) Settlement Management

Settlement is defined as payments (Pay-Ins) and receipts (Pay-Outs) for all the transactions done by the
members. Trades are settled through the Exchange’s settlement system.

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As illustrated in following figure, futures contracts have two types of settlements - the daily ‘Mark-to-Market’
settlement that happens on a continuous basis at the end of each day and the final settlement that happens
on the last trading day of the futures contract. Final settlement will be discussed later in detail.

Daily Settlement and Final Settlement

All outstanding positions of a Clearing Member, either brought forward or created during the day are marked
to market at the daily settlement price, at the close of trading hours on a day. Daily settlement price is the
closing price of the relevant futures contract for the trading day. However, in the absence of trading for a
contract during closing session, daily settlement price is computed as per the methods prescribed by the
Exchange from time to time. Such daily Mark-to-Market (MTM) settlement is done to take care of daily price
fluctuation for all trades. This is continued until the date of the contract expiry.

The daily settlement at the end of every trading day involves calculating the daily profits and losses on the
outstanding positions of members as follows:

• On the day of entering into the contract, it is the difference between the entry value and daily
settlement price for that day.

• On any intervening day, when the member holds an open position, it is the difference between
the daily settlement price for that day and the previous day’s settlement price.

For each clearing member, profits and losses on all positions are aggregated to a single net amount. The
information on MTM amount that is to be paid or received by the members is given through the Extranet at
the end of the day. The clearing house collects from those members with aggregate losses and pays to
those members with aggregate gains. Net amount of all payments and collections to/from all clearing
members will be zero.

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Besides the MTM, daily margin payments will also have to be made by the members.

Actual payment or receipt of funds will be made by the member on the next trading day i.e. T+1, ‘T’ being
the trade date.

c) Financial Management

All fund settlements take place through designated clearing banks. NCDEX presently has designated the
following 12 banks as the clearing banks through which funds to be paid and/or to be received must be
settled.

• Canara Bank
• Kotak Mahindra Bank Ltd
• HDFC Bank Ltd
• Tamilnad Mercantile Bank Ltd
• ICICI Bank Ltd
• Union Bank of India
• Axis Bank Ltd
• DCB Bank Limited
• Bank of India
• IndusInd Bank Ltd
• Punjab National Bank
• Yes Bank Ltd

Each clearing member needs to open a clearing accounts (Exchange dues account and Exchange
Settlement account) with one of the designated clearing banks. Clearing house, member and the clearing
bank enter into a tri-partite agreement.

The clearing house sends out daily Pay-in and Pay-out statements to clearing banks and instructs them for
debiting/ crediting the respective member’s account. The clearing bank will debit/credit the clearing account
of clearing members as per instructions received from NCDEX/NCCL.

Clearing members must authorize their clearing bank to access their clearing account for debiting and
crediting their accounts as per the instructions of NCDEX/NCCL, reporting of balances and other
operations, as may be required by NCDEX/NCCL from time to time.

A clearing member having funds obligation to pay is required to have a clear balance in his clearing account
on or before the stipulated pay-in day and stipulated time.

Following figure explains the flow of the funds settlement process: Funds Settlement Process

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Every clearing member must use the clearing accounts exclusively for clearing operations only, i.e. for
settling funds and other obligations to NCDEX, including payments of margins and penal charges. A
clearing member can deposit funds into this account but can withdraw funds from this account only in his
own name.

Margins

Margin is the deposit money that needs to be paid to buy or sell each contract. The margin required for a
futures contract is better described as performance bond or good faith money. The margin levels are set
by the Clearing House based on market volatility (market conditions) and change intraday.

The margin requirements for most futures range from 5% to 15% (subject to change from time to time) of
the value of the contract. In the futures market, a trader must maintain different types of margins such as
initial margin, additional margin, and extreme loss margin etc. These margins have been described in detail
in the section “Risk Management” in the module “Functioning and Regulation of Exchanges”.

Just as a trader is required to maintain a margin account with a broker, a clearing house member is required
to maintain collaterals/deposits with the clearing house against which the positions can be taken.

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9.2 Settlement

Process of settlement

Obligations are given to members

Client 1 MEMBER A

Makes arrangement for funds into Broker’s

bank a/c
NCCL
(Clearing
CLEARING Corporation)
BANKS

Banks credits the funds into Broker’s

bank a/c

Client 2 MEMBER B

Obligations are given to members

Futures contracts have two types of settlements:

• Mark to Market
• Final settlement

9.2.1 Mark to Market (MTM) settlement

This takes place on a continuous basis till the expiry of the contract at the end of each day (T+1, T= Trade
day).

Daily Mark to Market Settlement and final Mark to Market Settlement in respect of admitted deals in Futures
Contracts shall be cash settled by debit/ credit of the Clearing and Settlement account of Clearing Members
with the respective clearing bank.

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All positions (brought forward, created during the day, closed out during the day) of a Clearing Member in
Futures Contracts, at the close of trading hours on a day, shall be marked to market at the Daily Settlement
Price (for daily Mark to Market Settlement) and settled.

All positions (brought forward, created during the day, closed out during the day) of a Clearing Member in
Futures Contracts, at the close of trading hours on the Last Trading Day of the contract, shall be marked
to market at Final Settlement Price (for final settlement) and settled.

The Mark to Market losses shall be collected before the start of trading on T+1 day (‘T’ is the trade date).
The Clearing Members shall make the funds available in their clearing and Settlement account before 9:00
AM on T+1 day.

The daily Mark o Market pay-out of funds shall be done after 12:00 Noon, or as per timelines notified by
NCCL from time to time.

Open positions in a Futures Contract shall cease to exist after its expiration day.

9.2.2 Final settlement

This takes place on (E+2) basis where E is date of expiry of the futures contract.

The final settlement dates for the contracts are pre-decided and informed through the Settlement Calendar.
At NCDEX, 20th day of the delivery month is usually the date of expiry for most of the contracts. Product
notes for various commodities are available on website, specify expiry date of contracts.

Thus, a January expiration contract would expire on the 20th of January and a February expiry contract
would cease trading after the 20th of February. However, some of the agriculture, metals, and energy
contracts expire on different dates. If 20th (or date of expiry) happens to be a holiday, the expiry date shall
be the immediately preceding trading day of the Exchange, other than a Saturday.

Open Interest

Open interest refers to total number of futures contracts that are not closed on a particular day.

Calculation of Open Position

To understand the calculation of open positions, consider the following:

• Ram, a client of Trading Member A of NCDEX, sells 400 units of May Chana futures on 1st of
May. Simultaneously, he buys 700 units of May Jeera futures on 1st May. Later he sells 400
units of Jeera futures on 2nd May.

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 • Gopal, another client of Member A, sells 400 units of May Chana futures on 1st May and
thereafter buys 400 units of Chana futures on 2nd May.

• Varma, a third client, buys 200 units of May Jeera futures and simultaneously takes a short
position with 500 units of May Jeera futures on 1st May. On 2nd May, he buys another 200 units
of Jeera futures. On expiry of Chana and Jeera May futures:

• The positions held by Ram would be 400 units of short futures in Chana and 300 units of long
futures in Jeera.

• Gopal has squared off his position well before the expiration of May futures. Therefore, he does
not hold any open position on the date of expiry.

• Varma’s final open position would be 100 units of short futures in Jeera.

These open positions will be processed for final settlement. The details of the above example are
summarised in following table:

Example of Open Positions on Settlement Day

Trading Member A
Ram Gopal Varma

Chana Jeera Chana Jeera

Contract Contract Contract Contract
Day 1 400 S 700 B 400 S 200 B 500 S

Day 2 - 400 S 400 B 200 B -

On date of Expiry 400 S 300 B - 400 B 500 S

Ram: Varma:
Open Chana Contract - 400 S; Jeera Contract - 300 B Jeera Contract
Position Gopal 500 S - 400 B = 100 S
Nil

All open positions in a futures contract cease to exist after its expiration day. The clearing house handles
the daily as well as the final settlements.

Responsibility for Settlement

TCMs and STCMs are responsible for settlement of all the trades done on their proprietary account and
the trades of their clients.

PCMs are responsible for settling all the trades of participants, which they have confirmed to the Exchange.

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Trading Members (TMs) have to settle their trades through STCMs or PCMs. Even though TCMs allowed
to settle trades, can settle their trade through PCMs if they so desire.

Final Settlement of unclosed future contracts

Final settlement of futures contracts that are not closed by the end of the expiration day can be done in two
ways

• Physical delivery of the underlying asset or

• Cash settlement

Physical Delivery

Most of the futures contracts do not lead to actual physical delivery of the underlying asset. Only less than
2 % of the contracts end up in physical delivery.

The delivery place is very important for commodities with significant transportation costs.

For each commodity, the Exchange has a list of accredited warehouses for physical delivery.

There are about 289+ such warehouses with a storage capacity of 1 million MT in the case of NCDEX.
(Readers are advised to refer NCDEX website for latest updates

Under physical settlement, contracts can be broadly classified into the following three groups:

• Intention Matching

• Seller’s Option

• Compulsory Delivery with (Staggered Delivery provisions)

Intention for Delivery

If the buyer/seller is interested in physical delivery of the underlying asset, he must complete the delivery
marking for all the contracts within the time notified by the Clearing Corporation.

The intention for delivery must be submitted through the Web NCFE system. The intentions in all
commodities can be given up to one & half hour after the close of trading in respective contracts (not
beyond trading hours i.e. 09.00p.m.) on all the days during the period for marking delivery intention. E.g. if
trading in any contract closes at 5.00 p.m. on the days during the period of marking delivery intention, the
delivery intentions can be marked up to 6.30 p.m.

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Timings for submission of Delivery intention

Delivery intention can be submitted within specified time on all delivery intention marking days in respective
contracts

For the contracts which trade up to 5.00 p.m., the delivery intentions can be given up to 6.30 p.m.

For the contracts which trade up to 9.00 p.m., the delivery intentions can be given up to trading hours i.e.
9.00 p.m.

Timings for Marking Instruction for Devolvement of positions in case of options contract

Options Contract Timings (on expiry of the options contract)

Options contract where the underlying futures 5.45 p.m. to 6.45 p.m.
contract trade till 5.00 p.m.
Options contract where the underlying futures 10.00 p.m.to 11.00 p.m.
contract trade till 9.00 p.m.

Intention Matching

For intention matching contracts for agri commodities, sellers and buyers having open positions are
required to give their intentions/ notice to deliver to the extent of their open position, at least 5 trading days
before the expiry of the contract. Accordingly, the window for acceptance of delivery requests will be open
for 3 working days. The window will close 5 days prior to the expiry date (including the expiry date) of the
contract. Clients can submit delivery intentions up to the maximum of their open positions.

For intention matching contracts for non-agri commodities, sellers and buyers having open positions are
required to give their intentions/ notice to deliver to the extent of their open position, at least 3 trading days
before the expiry of the contract. Accordingly, the window for acceptance of delivery requests will be open
for 3 working days. The window will close 3 days prior to the expiry date (including the expiry date) of the
contract. Clients can submit delivery intentions up to the maximum of their open positions.

For intention matching contracts, requests for intention for delivery are sought from both the buyers and
sellers. The intentions from both the parties should match for quantity and warehouse location. Only the
minimum quantity of the request will be matched. If the intentions do not match, both the requests are cash
settled at the final settlement price.

Members giving delivery requests for the commodities are not permitted to square off their open positions
once such request is made. A penalty of 3% of final settlement price on the position squared off, if any, will
be levied besides any further action as deemed fit by the Exchange.

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Example: Refined Soya Oil, Crude Palm Oil and Kapas are among the futures contract traded on the
NCDEX for which delivery logic is intention matching.

Penalty for default

The penalty structure (subject to change from time to time) for failure to meet delivery obligations by the
sellers is as follows:

Total amount of penalty

• Futures Contracts on agri-commodities: 3% of Settlement price + replacement cost (difference

between settlement price and average of three highest of the last spot prices of 5 succeeding
days after the commodity pay-out date, if the average price so determined is higher than
settlement price, else this component will be zero.)

• Futures contracts on non-agri commodities: 3% of settlement price + replacement cost

(difference between settlement price and higher of the last spot prices on the commodity pay-
out date and the following day, if the spot price so arrived is higher than settlement price, else
this component will be zero.)

The norms for apportionment of the 3.0 % penalty collected as mentioned above is as follows:

• 1.75% of Settlement Price is deposited in the Settlement Guarantee Fund

• 0.25 % of Settlement Price is retained towards administrative expenses.

• 1 % of Settlement Price + replacement cost is given to the Buyer who was entitled to receive
delivery.

Buyers’ defaults are not permitted. The amount due from the buyers is recovered from the buyer as Pay in
shortage together with prescribed charges. Clearing Corporation has right to sell the goods on account of
such Buyer to recover the dues and if the sale proceeds are insufficient, the Buyer is liable to pay the
balance.

A seller who has got requisite stocks in the approved warehouses and / or has marked an intention during
staggered delivery period is not allowed to default and any such delivery default by seller is viewed seriously
and the Clearing Corporation takes suitable penal / disciplinary action against such members over and
above the prescribed penalty for delivery defaults.

The applicable taxes (if any like GST) on penalty for failure to meet delivery obligations is collected along
with the penalty amount.

Seller’s Option

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In Seller’s Option contracts, delivery obligation is created for all valid sellers’ requests received by the
Clearing Corporation. For Seller’s Option contract, the seller would be required to give their intention/notice
to the extent of his open position, at least 5 trading days prior to the expiry of the contracts. Accordingly,
the window for acceptance of delivery requests will be open for 3 working days. The window will close 5
days prior to the expiry date of the contract (including the expiry date).

The seller has the option of specifying the quantity and warehouse location for delivery. Although a buyer
can give the intention for a preferred warehouse, the delivery at the preferred warehouse is not guaranteed
if no sellers are available.

Members giving delivery requests for the commodities are not permitted to square off their open positions
once such request is made. A penalty of 3% of final settlement price on the position squared off, if any, will
be levied besides any further action as deemed fit by the Clearing Corporation.

Members are not allowed to create fresh positions in Seller Option and Intention Matching contracts during
the last five days of the expiry of the contract except in Refined soya oil, RBD palmolein, crude palm oil,
soybean and some international referenceable commodities failing which penalty would be levied as
prescribed by the Exchange, besides any further action as deemed fit by the Exchange.

If the seller does not mark his intention for delivery for Seller’s Option contract, and a short position is kept
open at the expiry of the contract a penalty of 0.5% on the Final Settlement Price (FSP) is levied on the
seller. Out of the penalty of 0.5%, 0.45% is provided to the counter party buyer and balance 0.05% is
transferred to the (Investment Protection Fund (IPF).

The penalty on seller in case of delivery default (default in delivery against open position at expiry in case
of compulsory delivery contracts, default in delivery after giving intention for delivery) shall be as follows
(penalty is subject to change from time to time):

Total amount of penalty

• Futures Contracts on agri-commodities: 3% of Settlement price + replacement cost (difference

between settlement price and average of three highest of the last spot prices of 5 succeeding
days after the commodity pay-out date, if the average price so determined is higher than
settlement price, else this component will be zero.)

• Futures contracts on non-agri commodities: 3% of settlement price + replacement cost

(difference between settlement price and higher of the last spot prices on the commodity pay-
out date and the following day, if the spot price so arrived is higher than settlement price, else
this component will be zero.)

The norms for apportionment of the 3.0 % penalty collected as mentioned above is as follows:

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 o 1.75% of Settlement Price is deposited in the Settlement Guarantee Fund
o 0.25 % of Settlement Price is retained towards administrative expenses.
o 1 % of Settlement Price + replacement cost is given to the Buyer who was entitled to receive
delivery

Currently, no seller’s option contract is traded. Earlier, soybean is among the futures contract traded on the
NCDEX for which delivery logic is Seller’s Option.

Seller’s Option with Staggered Delivery

If any seller having open position desires to give physical delivery at a specified delivery center, then the
buyer with corresponding open position as matched by the process put in place by the Clearing
Corporation, shall be bound to settle by taking physical delivery.

All open positions of those sellers who do not provide required information for physical delivery shall be
settled in cash with penalties as explained above.

The delivery request for such contracts will be on staggered basis where tender period would start on the
11th of every month in which the contract is due to expire. In case 11th happens to be a Saturday, a Sunday
or a holiday at the Exchange, the tender period would start from the next working day.

During the Tender period, if any delivery is tendered by seller, the corresponding buyer having open position
and matched as per process put in place by the Clearing Corporation, shall be bound to settle by taking
delivery from the delivery centre where the seller has delivered same.

The sellers can give their intention to give delivery during the tender period upto the expiry of the contract.
For example, for contracts expiring on 20th of the month, delivery intentions window will be open from 11th
and will close on 20th. Members can submit delivery intentions upto the maximum of their open positions.

Example: Soybean futures contract traded on the NCDEX is a contract with Seller’s Option with Staggered
Delivery.

Compulsory Delivery

Under Compulsory Delivery contracts, all the open positions on the expiry date shall have to be
compulsorily delivered either by giving delivery or taking delivery as the case may be. That is, the sellers
need to deliver the commodity and buyers need to accept the delivery. To allocate deliveries in the optimum
location for clients, the members will give delivery information for preferred location.

The corresponding buyer with open position as matched by the process put in place by the Clearing
Corporation shall be bound to settle by taking physical delivery. In the event of default by seller to give

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delivery, such defaulting seller will be liable to penalty as may be prescribed by the Clearing Corporation
from time to time.

Example: Futures contract for Sugar, Wheat, Guar Gum, Guar seed, Chana, Dhaniya, Maize, Cotton Seed
Oil Cake and Castor seed are among the contracts with Compulsory (Staggered) Delivery.

The penalty structure for failure to meet delivery obligations by the sellers is as follows:

• Total amount of penalty = 3.0 % + the difference between the Final Settlement Price (FSP) and
the average of three highest of the last spot prices of 5 (five) succeeding days after the expiry of
contract (E+ 1 to E +5 days), if the average spot price so determined is higher than FSP; else
this component will be zero.

• The penalty on seller in case of delivery default (default in delivery against open position at expiry
in case of compulsory delivery contracts, default in delivery after giving intention for delivery)
shall be as follows:

 Futures Contracts on agri-commodities: 3% of Settlement price + replacement cost

(difference between settlement price and average of three highest of the last spot prices of
5 succeeding days after the commodity pay-out date, if the average price so determined is
higher than settlement price, else this component will be zero.)

 Futures contracts on non-agri commodities: 3% of settlement price + replacement cost

(difference between settlement price and higher of the last spot prices on the commodity
pay-out date and the following day, if the spot price so arrived is higher than settlement price,
else this component will be zero.)

• The penalty on seller in case of delivery default (default in delivery against open position at expiry
in case of compulsory delivery contracts, default in delivery after giving intention for delivery)
shall be as follows:

 1.75% of Settlement Price is deposited in the Settlement Guarantee Fund

 0.25 % of Settlement Price is retained towards administrative expenses.

 1 % of Settlement Price + replacement cost is given to the Buyer who was entitled to receive
delivery.

• Buyer’s defaults are not permitted. The amount due from the buyers shall be recovered from the
buyer as Pay in shortage together with prescribed charges. Clearing Corporation shall have right
to sell the goods on account of such Buyer to recover the dues and if the sale proceeds are
insufficient, the Buyer would be liable to pay the balance.

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 • A seller who has got requisite stocks in the Clearing Corporation approved warehouses is not
allowed to default and any such delivery default by seller would be viewed seriously and the
Clearing Corporation shall take suitable penal/disciplinary action against such members over
and above the prescribed penalty as enumerated above.

• The buyers and sellers need to give their location preference through the front end of trading
terminal. If the sellers fail to give the location preference then the allocation to the extent of his
open position will be allocated to the base location.

(Since the penalty provisions and penalty rates are subject to change from time to time and also delivery
characteristics are also subject to change, the above inputs may be taken as theoretical inputs only and
readers will do well in keeping themselves updated from time to time from circulars issued by the Clearing
Corporation from time to and displayed on its website.)

Delivery Matching

At the end of the trading day during the tender period (in case of contracts following staggered delivery
mechanism), the delivery matching is done based on the available information. The corresponding buyer
matched by the allocation process (on a random allocation basis) put in place by the Clearing Corporation
will have to take the delivery on T + 2 (T being the tender day) day from the delivery centre where the seller
has delivered the commodity.

After the trading hours on expiry day, the delivery matching is done (on remaining outstanding positions)
based on the available information. The deliveries are matched on the basis of open positions and delivery
information received by the Clearing Corporation. The corresponding buyer matched by the allocation
process put in place by the Clearing Corporation will have to take the delivery on E + 2 (E being the contract
expiry day) day from the delivery centre where the seller has delivered the commodity.

In Seller’s Option contracts, delivery obligation is created for all valid sell requests received by the Clearing
Corporation. Simultaneously, the deliveries are allocated to the buyers with open positions on a random
basis, irrespective of whether a buy request has been submitted or not. While allocating the deliveries,
preference is given to those buyers who have submitted buy requests with preference for delivery location
– however this is subject to availability stock offered by seller – otherwise buyer will have to accept stock
from whichever location allocation is made.

In settling contracts that are physically deliverable, the clearing house:

• Randomly assigns longs to shorts (no relationship to original counterparties

• Provides a delivery venue – while allocating a venue, buyers preferred location is taken into
account to the extent deliverable stock is available.

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Successful matching of requests with respect to commodity and warehouse location results in delivery on
settlement day (i.e. T/E+2 basis).

After completion of the matching process, clearing members are informed of the deliverable/ receivable
positions.

Rejection of Delivery Request

Delivery requests can be rejected in the following circumstance:

Non availability of open positions to the extent of the delivery request - The request will be valid only to the
extent of the open positions for the member at client level in the respective contract. Any additional delivery
request will be rejected.

Delivery Period

All contracts materialising into physical deliveries are settled in a period of 2 days during the tender period
for staggered delivery period (T+2) and after expiry (E+2). If the tender date is T, then the delivery pay-in
and pay-out would take place on T+2 day. If such a T+2 day happens to be a Saturday, a Sunday or a
holiday at the Exchange, clearing banks or any of the service providers, pay-in and pay-out would be carried
out on the next working day. The exact settlement day for each commodity is specified by the Clearing
Corporation in the settlement calendar (specimen provided elsewhere in the book). Following figure
illustrates the overall flow chart for final settlement.

Settlement Price

The Settlement Price for any delivery allocation during staggered period (i.e. up to one day prior to expiry)
is the last available spot price for the respective contract.

On expiry, all contracts are settled at the Final Settlement Price (FSP).

The Final Settlement Price (FSP) is determined by the Clearing Corporation upon maturity of the contract.
The procedure for calculation of FSP for international reference-able commodity contracts and other
commodity contracts are clearly laid down by the Clearing Corporation in their respective product notes
and contract specifications.

For most of the commodities traded on NCDEX, the Final Settlement Price (FSP) is arrived at by taking the
simple average of the last polled spot prices (from basis centers of that commodity) of the last three trading
days viz., E0 (expiry day), E-1 and E-2. In the event of the spot prices for any one of the E-1 and E-2 is not
available, the spot price of E-3 would be used for arriving at the average. In case the spot prices are not
available for both E-1 and E-2, then the average of E0 and E-3 (two days) would be taken. If all the three

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days prices viz., E-1, E-2 and E-3 are not available, then only one day’s price viz., E0 will be taken as the
FSP.

The FSP under various scenarios of non-availability of polled spot prices shall be as under:

Scenario Polled Spot Price availability on FSP shall be simple average of last
E0 E1 E2 E3 polled spot prices on
1 Yes Yes Yes Yes/No E0, E1, E2
2 Yes Yes No Yes E0, E1, E3
3 Yes No Yes Yes E0, E2, E3
4 Yes No No Yes E0, E3
5 Yes Yes No No E0, E1
6 Yes No Yes No E0, E2
7 Yes No No No E0

In case of non-availability of polled spot price on expiry day (E0) due to sudden closure of physical market
under any emergency situations noticed at the basis centre, NCCL / NCDEX shall decide further course of
action for determining FSP in consultation with SEBI.

Location Premium and Discount

At NCDEX, every commodity has a basis centre and additional delivery centres. The seller has an option
to deliver the commodity either from basis centre or any additional delivery centre. If the seller delivers the
commodity from additional delivery centre and not from the basis centre, then the location premium or
discount will be applicable on the FSP. The location premium/discount is derived after considering certain
factors (like transportation cost between the two centers) as decided by the Exchange and it is announced
at the time of launch of the contract.

For example, the basis centre of Barley contract is Jaipur. On expiry, Clearing Corporation declared FSP
for Barley at Rs. 1,282.45 per quintal. The seller member has given his intention to deliver the commodity
from Sri Ganganagar, which is different from the basis centre of Jaipur. In this scenario, suppose the
applicable discount from delivering goods from Sri Ganganagar is Rs. 30 per per quintal. Thus, the price
receivable by the seller Member would be FSP-Applicable Discount i.e. Rs. 1,282.45 – Rs. 30 = Rs.
1,252.45.

Quality-related Premium/Discount

NCDEX contracts provide a standardised description for each commodity. The description is provided in
terms of quality parameters specific to the commodities. At the same time, it is understood that there could

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be some amount of variances in quality/weight etc. of the commodity, due to natural (especially in case of
Agri-commodities) causes that are beyond the control of any person. Therefore, NCDEX contracts also
provide tolerance limits for variances. A delivery is treated as good delivery and accepted if the quality of
the commodity lies within the tolerance limits.

To allow for the difference in quality, the concept of premium and discount has been introduced. Goods
that come to the authorised warehouse for delivery are tested by accredited assayer and graded as per
the prescribed parameters. The premium and discount rates are applied depending on the level of variation.
The goods which do not meet the quality parameters as per contract specs, are not accepted at the entry
level in warehouses.

The final settlement price payable by the party taking delivery is adjusted for the grade of commodity
delivered, as per the premium/ discount rates fixed by the Exchange. This ensures that some amount of
leeway is provided for delivery, but at the same time, the buyer taking delivery does not face windfall loss/
gain due to the quantity/ quality variation at the time of taking delivery. This, to some extent, mitigates the
difficulty in delivering and receiving exact quality/ quantity of commodity.

Let us consider the example of Gold. The key differentiator for gold is its purity. The purity of standard grade
Gold fixed by NCDEX is 99.95%. The computation of premium/discount on Gold = 100 – 100 (Purity level
for the delivered grade /purity level for the standard grade).

If a seller delivers 200 grams of Gold with purity of 99.99%, the final settlement price would be adjusted
with quality related premium, calculated as given below following table:

Computation of premium/discount on Gold

Quantity Sold 200 grams @ Rs.3000/gm. 6,00,000

Quantity delivered 200 grams

Purity on delivery unit 99.99 %

The factor of premium/discount for the delivered grade of gold = 100 – 100(.9999/.9950)

Premium for Delivering this grade of GOLD 0.49 %

Premium payable by receiving Member = 6,00,000 x 0.49% 2,940

Unmatched Positions

All unmatched positions are cash settled. The cash settlement is done only for the incremental gain/ loss
as determined based on the final settlement price.

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9.3 Cash Settlement

In the case of intention matching contracts , if the trader does not want to take/ give physical delivery, (and
in certain cases for sellers options contracts also if sellers do not give intention for delivery) all open
positions held till the last day of trading are settled in cash at the final settlement price. Similarly, any
unmatched, rejected or excess intention is also settled in cash. When a contract is settled in cash, it is
marked to the market at the end of the last trading day and all positions are declared closed.

For example, Vivek took a short position in five Silver 5kg futures contracts of June expiry on May 15 at
Rs.42,000 per kg. At the end of the last trading day of the contract i.e. 20th June, he continued to hold the
open position, without announcing delivery intention. The final settlement price of Silver on that day was
Rs.41,000 per kg. The computation of Vivek’s profit in the transaction is presented in following table:

Vivek’s final position

15th May Sold 5 Silver 5 kg futures contracts Futures Price : Rs. 42,000 per Kg

20th June Held on to open position; Settlement by cash :

FSP Settlement price FSP– Rs. 41,000 per Kg

Net effect Profit = Rs.25,000 ((42,000–41,000)*5*5 lots)

Though Vivek was holding a short position on Silver, he did not have to actually deliver the underlying
Silver. The transaction was settled in cash and he earned profit of Rs. 5,000 per trading lot of Silver. As
mentioned earlier, unmatched positions of contracts, for which the intentions for delivery were submitted,
are also settled in cash because may be there were not matching intentions from buyers in the same
contract.

In case of NCDEX, all contracts being settled in cash are settled on the day after the contract expiry date.
If the cash settlement day happens to be a Saturday, a Sunday or a holiday at the Exchange, clearing
banks or any of the service providers, Pay-in and Pay-out would be effected on the next working day.

9.4 Risk Management

There are two major types of risks involved with futures trading in commodities.

• The first is the ‘credit risk’, which arises due to non-fulfilment of obligations by a trading member.
For a trading member, similar risk arises if the client defaults on his obligations.

• The second risk is the ‘settlement risk’, which arises if settlement does not take place as expected
due to non-delivery of commodities by seller or default in making payment by buyer.

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Clearing houses undertake clearing of trades executed on exchanges. Similarly, National Commodity
Clearing Ltd. (NCCL), a wholly owned subsidiary of NCDEX (Clearing house), which undertakes clearing
of trades executed on NCDEX, has developed a comprehensive risk mitigation system for futures trading.
The key features of the risk management mechanism are as follows.

9.4.1 Credit Risk

Capital Adequacy

The financial soundness of the members is the key to risk management. Hence, the requirements for
membership in terms of capital adequacy (net worth and security deposit) are quite stringent. Both these
terms have been explained earlier.

The amount pertaining to ‘minimum liquid net worth’ is required to be paid through cheque or demand draft
only. However, the amount of ‘minimum collateral security’ deposit can also be paid in the form of ‘cash
equivalents’ (or ‘non-cash capital’). Cash equivalents can be in the form of bank guarantees (BG) or fixed
deposit receipts (FD) or Government of India securities. Approved shares or bullion (with appropriate
haircut) can also be treated as non-cash capital.

Bank guarantee must be as per the approved format and for a minimum period of one year. Similarly, fixed
deposits must be for a minimum period of 36 months from any of the approved banks.

NCCL is the approved custodian for acceptance of GOI securities and non-cash capital. All the noncash
securities are valued daily at the clearing price of National Stock Exchange or Bombay Stock Exchange
and a haircut rate as prescribed by the Exchange from time to time is applied. The total non-cash capital
provided by the member however should not exceed 50% of the total capital required. Any excess non-
cash capital will not be counted for effective deposit purposes.

Members, who wish to increase their capital limits, can do so by bringing in additional capital in the form of
cash, BG, FD, approved securities or bullion.

Margining System

NCCL imposes several margins for the trades done by the members, like initial margin, exposure margin /
Extreme loss margin, pre-expiry margin, additional margin, delivery margin, special margin (imposed by
either exchange or SEBI), calendar spread margin, selective margin, etc. The initial margin is computed
on-line using state-of-art NCDEX Risk Management System (RMS), which is a scenario based system.
The objective of RMS is to identify overall risk in a portfolio of all futures contracts for each member. Its
overriding objective is to determine the largest possible loss that a portfolio might reasonably be expected
to suffer from one day to the next, based on 99% VaR methodology.

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Concepts of initial margin, mark to market margin, additional margin and special margin were introduced in
Book

Initial margin

This margin shall be applicable on all positions of members of TCM up to the client level. The initial margins
are arrived at as follows:

• Client’s position shall be netted at the level of individual clients and grossed across clients without
any set-offs between the clients

• Proprietary positions will be netted at member level, without any set-offs between clients and
proprietary positions

Initial margin shall be payable upfront by the members in accordance with the margin computation
mechanism and/or system as may be adopted by the Exchange periodically.

Mark to Market (MTM)

Mark to Market process is carried out every day and on T+1 basis pay in and pay out happens – whereby
members who have gains receive the money and members who have negative gains have to pay. The
pay in and pay out is carried from Members’ clearing and settlement account maintained by them with
clearing banks.

Pre-expiry margin

This margin is charged as additional margin for all commodities expiring during the current month. It is
charged on a cumulative basis from 11 days prior to the expiry date (including the expiry date). This is done
to ensure that only interested parties remain in the market and speculators roll over their positions to
subsequent months.

Delivery Margin

This margin is charged only in the case of positions materializing into delivery. Members are informed about
the delivery margin payable. It is added to the initial margin. Margins for delivery are to be paid the day
following expiry of contract till final pay-in/pay out happens

Special Margin

This margin is levied when there is more than 20% uni-directional movement in the price from a
predetermined base. The base could be the closing price on the day of launch of the contract or the 90
days prior settlement price. This is mentioned in the respective contract specification. It can also be levied

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by market regulator if market exhibits excess volatility. If required by the regulator, it has to be provided in
by cash. This is collected as extra margin over and above normal margin requirement.

Margin for Calendar Spread positions

Calendar spread is defined as the purchase of one delivery month of a given futures contract and
simultaneous sale of another delivery month of the same commodity with the same client code on the same
Exchange.

The Exchange charges minimum 50% of the initial margin (inclusive of exposure / extreme loss & volatility
margin) on the positions in:

• Different month contracts on the same underlying commodity and

• Two contract variants having the same underlying commodity.

In case of spread trades, additional and special margins are not levied.

Accordingly, the margin on calendar spread positions continues to be minimum 50% of the initial margin
(inclusive of exposure/ extreme loss & volatility margin) resulting in around 75% margin benefit.

Such benefit is given only if there is positive correlation in the prices of the months under consideration and
the far month contracts are sufficiently liquid. However, calendar spread positions in the far month contract
are considered as naked position three days before expiry of near month contract. Gradual reduction of
the spread position is done at the rate of 33.3% per day from 5 days prior to expiry.

Selective margin call

The Exchange, at its discretion, may make selective margin calls only for those members, whose variation
losses or initial margin deficits exceed a threshold value prescribed by the Exchange.

Since Margins are subject to change from time to time, readers should refer to Exchange websites to keep
themselves updated with margin requirements

9.4.2 Settlement Risk

Mark to Market Settlement System

All the open positions of members are marked to market every day, based on the daily settlement price
(DSP) for each contract. The difference is settled in cash on a T+1 basis. In other words, the daily profits
or losses of the traders due to daily price movement are calculated every day and settled during the
following day.

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On the day of entering into the contract, the difference between the entry price and daily settlement price
is calculated. On the expiry date, if a member has an open position, the difference between the final
settlement price and the previous day’s settlement price is considered. On the intervening days when the
member holds an open position, the difference between the daily settlement price for that day and the
previous day’s settlement price is calculated. The daily settlement price notified by the Exchange is binding
on all members and their constituents.

In case of daily settlement, wherever members have to pay to the Exchange to cover losses, the payin
must be made before 11.00 Hrs on the subsequent day. This ensures that the obligations of members are
valued at the most recent market prices and adequate margins are maintained to mitigate default risk. In
case of profits, pay-out would be made by 13.00 Hrs on the subsequent day. For example, assume that on
a day in October, a trader buys a December futures contract for Sugar at Rs. 3400 per quintal. The daily
settlement price for that day is Rs. 3450 per quintal. Hence, the buyer of the contract makes a profit of Rs.
50per quintal, which member can collect in the form of pay-out during the subsequent day. However, the
seller of the contract would incur a loss of Rs. 50 per quintal, which seller member settles (pay-in) before
11:00 A.M. during the subsequent day. For exchange it is a zero sum game (Pay in and pay out timings
are announced from time to time

Next day, both the buyer and seller would start their day’s position with Rs. 3450 per quintal. The contract
would be marked to market in the same manner at the end of the day.

Following table gives an example of continuous mark to market settlements till the contract is squared off.

Example of a Mark to Market Settlement

Day Buy Position Sell Position Daily Settlement Price Profit/(Loss)

(DSP)

Day 1 Rs. 3400 per quintal Rs. 3400 per quintal Rs. 3450 per quintal Buyer : Rs.50

Seller : (Rs.50)

Day 2 Rs. 3450 per quintal Rs. 3450 per quintal Rs. 3425 per quintal Buyer : (Rs.25)

Seller : Rs. 25

Day 3 Rs. 3425 per quintal Rs. 3425 per quintal Rs. 3435 per quintal Buyer : Rs.10

Seller : (Rs.10)

Day 4 Squares off @ Squares off @

Rs. 3425 per quintal Rs. 3420 per quintal.

Total Net Gain: Rs. 25 Net Loss: Rs. 20

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9.4.3 Fixing Position Limits

For each member/client, a position limit is fixed. This limit is defined as the maximum open interest that a
member or an individual client can hold in any commodity at any point of time. The limit is expressed either
in value terms or quantity terms. For the following reasons, it is imperative that there must be a limit on the
open position that an individual client or member can hold.

• This limit ensures that no individual client or member is in a position to unduly influence price
movement in the futures or spot market. This will particularly prevent price manipulation at expiry.
In other words, the final settlement price at expiry of the contract should not be distorted.

• A client or member, by virtue of holding a disproportionately large percentage of the open interest,
should not acquire the market concentration or power to move price in a direction favorable to him.

• Also, a large open position for an individual client or member is vulnerable to large mark to-market
losses (in case of adverse price movement) which the client or member may not be able to bear
and may pose risk to exchange and market

• This will prevent ‘short squeeze’, so that open interest that can be converted into delivery at expiry
of the contract is not higher than the stock available for delivery.

• More importantly, if a few individual clients or members collectively hold a very large portion of the
open interest, they can collude amongst themselves and such a situation can potentially lead to
market manipulation and short squeeze. (where short position exceeds stocks available for
delivery)

The Exchange monitors all clearing members’ positions. In case the members exceed the limit, they must
adjust their positions to bring the position within the prescribed unit.

9.4.4 Fixing Exposure Limits

As a risk mitigation step, an exposure limit is fixed for each member. This limit is defined as the maximum
open interest that a member and his individual client can hold across all contracts put together at any point
of time. This limit is linked to the liquid net worth of the member available with the Exchange. Exposure
limits are specified as a multiple of the liquid net worth, i.e. a member can have exposure limit of ‘x’ times
his liquid net worth.

The member is not allowed to trade once the exposure limits have been exceeded on the Exchange.
Periodic alerts are generated before members is about to reach 90% threshold. Once 90% threshold is
reached, trading terminals of member are put on “Square Off” whereby they cannot take any fresh exposure
– till such time either they reduce existing exposure or bring in additional funds/collaterals whereby

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exposure limit becomes available. The position limits are revised from time to time as directed by regulators.
The updated position limits are as under: (July 2018).

Position limits

Member* Client**
S.No. Commodity Symbol Unit Near Near Month
Overall Overall
Month
AGRI COMMODITIES
1 Barley BARLEYJPR MT 100,000 25,000 10,000 2,500
2 Castor Seed CASTOR MT 150,000 37,500 15,000 3,750
3 Chana CHANA MT 300,000 75,000 30,000 7,500
Undecorticated
4 Cotton Seed COCUDAKL MT 800,000 200,000 80,000 20,000
Oil Cake
5 Cotton 29 MM COTTON Bales 3,600,000 900,000 360,000 90,000
Crude Palm
6 CPO MT 1,000,000 250,000 100,000 25,000
Oil
7 Coriander DHANIYA MT 30,000 7,500 3,000 750
8 Guar Gum GUARGUM5 MT 24,000 6,000 2,400 600
GUAR1MT
9 Guar Seed MT 160,000 40,000 16,000 4,000
GUARSEED10

10 Jeera JEERAUNJHA MT 24,000 6,000 2,400 600

11 Kapas KAPAS MT 1,600,000 400,000 160,000 40,000
Maize Feed / MAIZEKHRIF
12 Industrial MAIZERABI MT 2,600,000 650,000 260,000 65,000
Grade MAIZESOUTH
13 Pepper PEPPER MT 3,600 900 360 90
Rapeseed
14 RMSEED MT 800,000 200,000 80,000 20,000
Mustard Seed
Sugar
15 SUGARM MT 650,000 162,500 65,000 16,250
(M Grade)
16 Soybean SYBEANIDR MT 1,100,000 275,000 110,000 27,500
Degummed
17 SYODEGUM MT 500,000 125,000 50,000 12,500
Soy Oil
Refined Soy
18 SYOREF MT 500,000 125,000 50,000 12,500
Oil

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 19 Turmeric TMCFGRNZM MT 50,000 12,500 5,000 1,250
20 Wheat WHEATFAQ MT 2,500,000 625,000 250,000 62,500

• Note 1: *A member’s open interest limit at overall (all contracts) level will be either the absolute
number indicated above or 15% of the total market wide open position in the commodity, whichever
is higher. In case of near month limit, a member’s open interest limits will be one fourth of the
member’s overall position limit in that commodity.

• Note 2: **A client’s open interest limit at overall (all contracts) level will be the absolute number
indicated above for the commodity. In case of near month limit, a client’s open interest limits will
be one-fourth of the client’s overall position limit in that commodity.

Bona fide hedger clients may seek exemption as per approved Hedge Policy of the Exchange notified vide
Circular No. NCDEX/CLEARING-019/2016/246 dated September 28, 2016. However, such limits are given
to Bona fide hedgers after exchange is satisfied with their hedging requirements. Hedgers cannot use such
hedge limits for trading. Such limits are delivery-based limits.

The Exchange wide Position Limits are as follows:

Commodity Unit Exchange wide Position

Limits (50% of deliverable supply)

Barley MT 1,000,000
Castor Seed MT 750,000
Chana MT 6,000,000
Undecorticated Cotton Seed Oil Cake MT 4,000,000

Cotton 29 MM BALES 18,000,000

Crude Palm Oil MT 5,000,000
Coriander MT 300,000
Guar Gum MT 240,000
Guar Seed MT 800,000
Jeera MT 240,000
Kapas MT 8,000,000
Maize Feed / Industrial Grade MT 13,000,000
Pepper MT 36,000
Rapeseed Mustard Seed MT 4,000,000
Sugar (M Grade) MT 13,000,000
Soybean MT 5,500,000
Degummed Soy Oil MT 2,500,000

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 Refined Soy Oil MT 2,500,000
Turmeric MT 500,000
Wheat MT 50,000,000

Another aspect of Position limit is Concentration of open positions with few participants.

To further strengthen the Risk Management Framework & as directed by SEBI the Exchange stipulates
Concentration Margin, when the overall market wide Open Interest (OI) of a commodity exceeds the
specified Threshold Limit of Open Interest (OI) for that commodity. The list of commodity wise threshold
limits is provided later in this chapter.

The Concentration Margin is levied at clearing member level and client level based on the following criteria

Clearing Member Level: The percentage share of a clearing member’s open interest to the market wide
open interest in each commodity. Bonafide hedgers are provided need-based position limits over and
above normal position limits available to them. The Concentration Margin is applicable in respect of all
contracts in the commodity unless specified otherwise is applicable as follows:

Clearing Member Open Interest (OI) as % of Market-wide OI in the commodity

Slab Concentration Margin

up to 10% NIL
10% - 15% 2.50%
15% - 25% 5.00%
25% - 35% 7.50%
35% and above 10.00%

Client Level: The percentage share of client’s open interest to the market wide open interest in a given
commodity. The Concentration Margin is applicable in respect of all contracts in the commodity unless
specified otherwise and is applicable as under:

Client OI as % of Market-wide OI in the commodity

Slab Concentration Margin

up to 3% NIL
3% - 5% 1.50%
5% - 10% 2.50%
10% - 15% 3.50%
15% and above 5.00%

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The concentration margin is be applicable at a specific client level and clearing member level for a
commodity i.e. only those members/clients having OI that is eligible for charging of Concentration Margin
as per the above tables. This margin is be over and above all other margins as may be applicable.

The Concentration Margin corresponding to a slab is applied only on the incremental open interest for that
slab.

Concentration margins are applicable to select commodities only when the overall market wide OI of a
commodity exceeds the specified Threshold Limit of OI for that commodity. The Threshold Limits for the
select commodities presently prescribed are given as under – however they are subject to change from
time to time

Commodity Measure Threshold Limits

BARLEY MT 28,500
CHANA MT 342,500
CHILLI TEJA MT 13,500
CORIANDER MT 61,500
29 MM COTTON Lot 60,000
COTTONSEED OIL CAKE MT 243,500
CRUDE PALM OIL MT 500,000
GUAR GUM MT 36,000
GUAR SEED MT 153,000
JEERA MT 31,000
V 797 KAPAS Lot 62,500
MAIZE - FEED/ INDUSTRIAL GRADE MT 70,500

REFINED SOY OIL MT 330,000

RAPE SEED-MUSTARD SEED MT 229,000
SHANKAR KAPAS Lot 62,500
SOYABEAN MT 356,500
SUGAR (M GRADE) MT 200,000
TURMERIC MT 40,000
WHEAT MT 40,000

9.4.5 Fixing Intra-day Price Limit

To control wide swings in prices, an intra-day price limit is fixed. The maximum price movement during the
day can be +/- x% of the previous day’s settlement price for each commodity. If the price hits the intra-day
price limit (at upper side or lower side), there will be a cooling period of 15 minutes.

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During the cooling period, trading in that particular contract will be suspended and normal trading will
resume after the cooling period. When trading resumes after the cooling period, the base price will be the
last traded price before the commencement of cooling period. There would be no cooling period if the price
hits the intra-day limit during the last 30 minutes of trading. For most of the agri and non-agri futures traded
on NCDEX, the intra-day price limit is 4 percent and 9 percent respectively (these limits are again subject
to change from time to time)

9.4.6 Near Month Limits

For orderly functioning of the market and to ensure smooth rollover of positions in contracts, stringent limits
for near month contracts are set. For example, futures contract for commodities expiring on the 20th day
of the month, near month limits are applicable from the first day of the contract expiring month. Certain
open position limits are set for specific commodities, individually for clients and collectively for a member.

Box 9.1:

Daily price limit (DPL) is (+/-) 3%. Once the 3% limit is reached, then after a period of 15 minutes this
limit is increased further by 1%. The trading is permitted during these 15 minutes period within the 3%
limit. After the DPL is enhanced, trades shall be permitted throughout the day within the enhanced total
DPL of 4%

For fixing DPL slabs, base price is taken as previous day’s closing price of the contract, however for the
first trading day (launch day) of each contract, Exchange determines base price as under:

a) Volume Weighted Average Price (VWAP) of the first half an hour, subject to minimum of ten
trades
b) If sufficient No. of trades are not executed during the first half an hour, then the VWAP of first one
hour trade subject to minimum of ten trades.
c) If enough No. of trades are not executed even during the first hour of the day then VWAP of the
first ten trades during the day.

The base price arrived as per (a) or (b) or (c) above shall is calculated by the Exchange and is used to
determine DPL for the remaining part of the day.

(Near month position limits have been indicated in earlier pages when table for position limits is provided)

9.4.7 Additional Base Capital

A member is required to pay an additional base capital, when the member’s base capital has been
exhausted due to the current positions. A member can also voluntarily increase the base capital anytime
to take it to higher positions over and above the normal base capital. The additional base capital can be
paid in the form of cash or non-cash equivalents as listed below:

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 o Cash
o Cash Equivalent:
o Bank Guarantee (BG)
o Fixed Deposit Receipt (FDR)
o Approved securities in Demat form deposited with approved Custodians
o Approved Agricultural Commodities in Demat (E-Repository Account balance) form deposited
with approved Custodians
o Bullion (Gold and Silver) in in Demat form deposited with approved Custodians
o Approved Gold Exchange Traded Fund (ETF) in Demat form deposited with approved
custodians.
o Approved Steel Long as Collateral in Demat form deposited with approved custodians.

9.4.8 Real-time Monitoring and Alert System

NCCL’s online monitoring system continuously keeps a watch over the margin levels and open positions
of members. The monitoring is done on a real time basis, through ‘per call risk management system’
(PRISM).

The system generates alerts whenever the initial margin requirement or the exposure margin requirement
of a member reaches 70% of the available capital or the open position of the member approaches the limit.
The member will have to adjust his position to bring it back within the limit or contribute additional funds.

The PCMs are monitored for TCM’s value and position violation, while TCMs are monitored for contract
wise position limit violation. In turn, TCMs should monitor the margin limit and order limit of all their clients,
through their trading terminals. A TCM may set exposure limits for a user who is clearing and settling
through him.

Whenever any member fails to rectify the violations of margin or position limits, the Exchange can withdraw
any or all the rights of such members, including withdrawal of trading and/or clearing facility of participants
clearing through such TCMs. Moreover, the outstanding positions of such members and/ or constituents
clearing and settling through such members can be closed at any time at the discretion of the Exchange,
to the extent possible, by placing counter orders. This can be done without any notice to the members
and/or constituents. Such action is final and binding on the members and/ or constituents.

The Exchange can initiate further risk containment measures with respect to the open positions of the
members and/or constituents. These could include imposing penalties, collecting appropriate deposits,
invoking bank guarantees/fixed deposit receipts, realising money by disposing off the securities and
exercising such other risk containment measures that the Exchange considers necessary.

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9.4.9 Member Deposit Fund

Every Commodity Exchange maintains a separate Member Deposit Fund created out of the capital
contributed by the members. This fund, by guaranteeing financial settlement of bona fide transactions of
the members of the Exchange, instils confidence in the minds of market participants.

In the event of a clearing member failing to meet his obligations to the Exchange in respect of cases
specified pursuant to byelaws, the Exchange may, at its discretion, utilise the fund to the extent and in such
manner as necessary.

Following settlement obligations are specifically excluded by the Exchange:

• Settlement obligation arising out of any deal where in the opinion of the Exchange, there is prima
facie suspicion of fraud, misrepresentation or malpractice

• Settlements obligations subject to any investigation by the relevant authority of either the Exchange
or by any statutory authority

• Settlements deals which are not properly executed in accordance with the respective byelaws,
rules and regulations of the Exchange

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Module 10 : Regulatory Framework
At present, the trading in commodity market in India is regulated by there are three tiers of regulation of
forward/futures trading system in India, viz. Government of India, Securities and Exchange Board of India
(SEBI) and Commodity Exchanges. The trading rules and procedures of recognized commodity derivatives
exchange and commodity brokers are regulated by Securities and Exchange Board of India (SEBI)–A
statutory body established under SEBI Act, 1992. The need for regulation of forward /futures in commodity
trading system in India arises on account of the fact that the benefits of futures markets can accrue only in
competitive conditions. Proper regulation is needed to create competitive conditions. In the absence of
regulation, unscrupulous participants could use these leveraged contracts for manipulating prices. This
could have undesirable influence on the spot prices, thereby affecting interests of society at large.

Regulation is also needed to ensure that the market has appropriate risk management system. In the
absence of such a system, a major default could create a chain reaction. The resultant financial crisis in a
futures market could create systemic risk. Regulation is also needed to ensure fairness and transparency
in trading, clearing, settlement and management of the Exchange to protect and promote the interest of
various stakeholders, particularly non-member users of the market.

As noted above FMC was brought under Ministry of Finance and thereafter FMC was merged with SEBI
by Government Notification – thereby bringing Equity and Commodity Exchanges were brought under
single regulator i.e. Security & Exchange Board of India (SEBI).

This ushered in era of common regulator for Capital Markets and Commodity Markets. However it is worth
mentioning that countries like USA has separate regulator for Capital Markets (Securities and Exchange
Commission (SEC) and Commodity Futures Trading Commission (CFTC) for Commodity markets)

This was the first ever merger of two regulators in the country. This historic merger paved the way to
implement an array of new reforms towards developing commodity derivatives market with superior and
efficient technology, risk management, supervision, surveillance, enforcement, liquidity and investor
protection.

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Box 10.1

The Forward Contracts (Regulation) Act - Now repealed (For Historical perspective)

The Forward Contracts (Regulation) Act, 1952, a Central Act, used to govern commodity derivatives
trading in India. The Act defines various forms of contract. The Act envisaged three-tier regulation.

 Exchange: Forward trading in commodities notified under Section 15 of the Act can be conducted
only on the Exchanges, which are granted recognition by the central government. All the
Exchanges, which deal with forward contracts, are required to obtain certificate of registration
from the FMC. Besides, they are subjected to various laws of the land like the Companies Act,
Stamp Act, Contracts Act, Forward Contracts (Regulation) Act and various other legislations. The
exchanges can prepare their own Articles of Association, Rules and Regulations, byelaws and
regulate trading on a day-to-day basis.
 Forward Markets Commission: The Forward Markets Commission (FMC), a statutory body set
up under the Ministry of Consumer Affairs and Public Distribution in 1953 under the Forward
Contracts (Regulation) Act, 1952, regulated commodity futures trading in India for six decades till
the beginning of September 2013. Later on, the FMC was brought under the Ministry of Finance.
The Commission used to approve the rules and byelaws of the Exchange and provided regulatory
oversight. It also acquired concurrent powers of regulation while approving the rules and byelaws
or by making such rules and byelaws under the delegated powers.
 Central Government: Ministry of Finance under the Government of India is the ultimate
regulatory authority. Only those associations, which are granted recognition by the Government,
are allowed to organize forward trading in permitted commodities. Government has the power to
suspend trading, call for information, nominate directors on the Boards of the Exchanges, and
supersede Board of Directors of the Exchanges etc. These most of these powers were delegated
to regulator(s) from time to time.

Functions of FMC

As per the Forward Contracts (Regulation) Act, 1952, the functions of the FMC were:

 To advise the Central Government in respect of the recognition of or the withdrawal of recognition
from any association or in respect of any other matter arising out of the administration of this Act.
 To keep forward markets under observation and to take such action in relation to them, as it may
consider necessary, in exercise of the power assigned to it by or under this Act.

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  To collect and whenever the Commission thinks it necessary to publish information regarding the
trading conditions in respect of goods to which any of the provisions of this Act is made applicable,
including information regarding supply, demand and prices, and to submit to the Central
Government periodical reports on the operation of this Act and on the working of forward markets
relating to such goods.
 To make recommendations generally with a view to improving the organization and working of
forward markets.
 To undertake the inspection of the accounts and other documents of any recognized association
or registered association or any member of such association, whenever it considers it necessary.
 To perform such other duties and exercise such other powers as may be assigned to the
Commission by or under this Act, or as may be prescribed.

The role of FMC in the commodities markets were similar to the role of SEBI in the stock markets.
The major area of difference was that while the SEBI was required to conduct research into the
different areas relating to the stock exchanges and the securities market, the FMC was required to
collect and publish information regarding supply, demand and prices of commodities.

After taking over the regulation of the commodities market, SEBI has initiated numerous progressive steps
to strengthen the commodity derivatives ecosystem in the country. Few of them are:

 New norms for exchange approved WSPs, warehouses and assayers: to strengthen the delivery
infrastructure;

 Revised the criteria for eligibility, retention, and re-introduction of derivative contracts on
Exchanges;

 Issued guidelines w.r.t. providing additional position limits for Hedgers;

 Issued norms on the Settlement Guarantee Fund

 Prescribed the framework for staggered delivery, early delivery, early pay-in facility

 Issued norms for delivery default penalty, fixing of the final settlement price (FSP) and in some
cases change in expiry dates of futures contracts.

Further, in order to deepen and widen the commodity market, the SEBI took a series of initiatives such as
allowing hedge funds to invest in commodity derivatives and allowing the introduction of safer products
such as commodity options to provide alternative hedging instrument to farmers. Recently, bank’s
subsidiaries were also allowed to provide broking services and be a professional clearing member.

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However, banks themselves are not yet permitted to trade in commodity derivatives. SEBI has also issued
detailed norms with regard to the Investor Protection Fund (IPF) and related matters.

10.1 The Securities Contract Regulation Act 1956

The Securities Contract Regulation Act 1956 and Securities Exchange and Board of India, governs and
regulates commodity derivatives trading in India. The Act envisages two tier system for the purpose of
regulating the commodities market regulation –

Securities and Exchange Board of India – The Securities and Exchange Board of India (SEBI) was
established on April 12, 1992 in accordance with the provisions of the SEBI Act 1992.SEBI is an
autonomous body as declared by Government of India since 1992.

Pursuant to modifications in the Finance Act, 2015 with consequent amendments in the Securities
Contracts (Regulation) Act, 1956 (SCRA) and repeal of the Forward Contracts (Regulation) Act, 1952
(FCRA), the Forward Markets Commission (FMC) was dissolved and the regulation of Commodities
Derivatives Markets now vests with the Securities and Exchange Board of India (SEBI), with effect from
September 28, 2015. The Board provides a framework for functioning and regulatory oversight of the
Commodity Exchanges.

Exchanges – Trading in Commodities can be conducted only on the Exchange platform, granted recognition
by SEBI and under various laws of the land like Companies Act, Stamp Act, Finance Act and other
legislations. The Exchanges can formulate their own Articles of Association, Rules, Regulations, and Bye
Laws and regulate the trading on day to day basis in adherence with the SEBI guidelines and procedures.

Functions of SEBI

As per the SEBI Act 1992, the functions of the SEBI are:

• Protect the interests of investors in securities and to promote the development of, and to regulate
the securities market, by such measures as it thinks fit.

• Without prejudice to the generality of the foregoing provisions, the measures referred to therein
may provide for—

 regulating the business in stock exchanges and any other securities markets;

 registering and regulating the working of stock brokers, sub-brokers, share transfer agents,
bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment advisers and such other intermediaries who may
be associated with securities markets in any manner;

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 registering and regulating the working of the depositories, participants, custodians of securities,
foreign institutional investors, credit rating agencies and such other intermediaries as the Board
may, by notification, specify in this behalf;

 registering and regulating the working of venture capital funds and collective investment
schemes], including mutual funds;

 promoting and regulating self-regulatory organisations;

 prohibiting fraudulent and unfair trade practices relating to securities markets;

 promoting investors‘ education and training of intermediaries of securities markets;

 prohibiting insider trading in securities;

 regulating substantial acquisition of shares and takeover of companies;

 calling for information from, undertaking inspection, conducting inquiries and audits of the [stock
exchanges, mutual funds, other persons associated with the securities market], intermediaries
and self-regulatory organizations in the securities market;

 calling for information and records from any person including any bank or any other authority or
board or corporation established or constituted by or under any Central or State Act which, in the
opinion of the Board, shall be relevant to any investigation or inquiry by the Board in respect of
any transaction in securities;]

 calling for information from, or furnishing information to, other authorities, whether in India or
outside India, having functions similar to those of the Board, in the matters relating to the
prevention or detection of violations in respect of securities laws, subject to the provisions of
other laws for the time being in force in this regard: Provided that the Board, for the purpose of
furnishing any information to any authority outside India, may enter into an arrangement or
agreement or understanding with such authority with the prior approval of the Central
Government;]

 performing such functions and exercising such powers under the provisions of the Securities
Contracts (Regulation) Act, 1956 (42 of 1956), as may be delegated to it by the Central
Government;

 levying fees or other charges for carrying out the purposes of this section;

 conducting research for the above purposes;

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  calling from or furnishing to any such agencies, as may be specified by the Board, such
information as may be considered necessary by it for the efficient discharge of its functions;

 performing such other functions as may be prescribed.

10.2 Rules Governing Commodity Derivatives Exchanges

Securities and Exchange Board of India (SEBI) prescribes regulatory oversight to define the best practices
and to ensure financial integrity, market integrity and to protect and promote interest of customers/non-
members. The SEBI has prescribed various regulatory directives / measures for smooth functioning of the
Commodity Exchanges, such as:

 Spot Price Polling Mechanism

 Staggered delivery, early delivery system, early pay-in facility, penalty on delivery default, fixation
of Final Settlement Price (FSP) and changes in expiry dates

 Position Limits for Commodity Derivatives, clubbing of open positions, penalties for violation of
position limits

 Broad Guidelines on Algorithmic Trading for National Commodity Derivatives Exchanges

 Enhanced Supervision of Stock Brokers/Depository Participants

 Disclosure of Proprietary Trading by Commodity Derivatives Broker to Client and “Pro - account”
Trading terminal

 Permission for trading in futures contracts and modification in contract specifications at exchange
level

 Revised Warehousing Norms in the Commodity Derivatives Market for Agricultural and Agri-
processed Commodities Traded on the National Commodity Derivatives Exchange

 Criteria for Settlement Mode of Commodity Derivative Contracts

 Reduction in Daily Price Limits & Near month Position Limits for Agricultural Commodity Derivatives
and Suspension of Forward Segment

 Daily Price Limits (DPL) for Non-Agricultural Commodity Derivatives/ First Day DPL for All
Commodity Derivatives

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  Core Settlement Guarantee Fund, Default Waterfall and Stress Test & Core SGF and standardised
stress testing for credit risk for commodity derivatives

 Mechanism for regular monitoring of and penalty for short-collection/non-collection of margins from
clients

 Additional risk management norms for National Commodity Derivatives Exchanges,

Comprehensive Risk Management Framework for National Commodity Derivatives Exchanges

 Regulatory Framework for Commodity Derivatives Brokers

10.3 Rules Governing Intermediaries

In addition to the provisions of the Forward Contracts (Regulation) Act 1952 (now SCRA 1956 as amended
from time) and rules framed thereunder from time to time by the regulator, Exchanges are governed by
their own rules and byelaws, as approved by the SEBI.

The following is the summary of the important regulations that govern NCDEX, pertaining to trading and
clearing. The detailed byelaws, rules and regulations are available on the NCDEX website.

10.3.1 Trading

The NCDEX provides an automated trading facility in all the commodities admitted for dealings on the
derivative market. Trading on the Exchange is allowed only through approved workstation(s) located at the
office(s) of a trading member as approved by the Exchange. If the approved workstation is connected to
any other workstation through LAN or some other network, it shall require approval of the Exchange.

Each trading member is required to have a unique identification number that is provided by the Exchange.
This number shall be used to log in (sign on) to the trading system. A trading member has a non-exclusive
permission to use the trading system as provided by the Exchange in the ordinary course of business as a
trading member. However, the trading member does not have any title, rights or interest whatsoever with
respect to the trading system, its facilities, software and information provided by the trading system.

For the purpose of accessing the trading system, the member will install, use and maintain the equipment
and software as specified by the Exchange, at his own cost. The Exchange has the right to inspect the
equipment and software used for the purposes of accessing the trading system, at any time.

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10.3.2 Trading Members and Users

From time to time, trading members are entitled to appoint authorised persons or approved users (subject
to such terms and conditions, as may be specified by the relevant authority). Trading members have to
pass a certification program, which has been prescribed by the Exchange. In case of trading members,
other than individuals or sole proprietorships, such certification program has to be passed by at least one
of their directors /employees /partners /members of the governing body. The appointment of approved
users is subject to the terms and conditions prescribed by the Exchange. Each approved user is given a
unique identification number through which he will have access to the trading system. An approved user
can access the trading system through a password and can change the password periodically.

The trading member or its approved users are required to maintain complete secrecy of its/their
password(s). Any trade or transaction done by use of password of any approved user of the trading
member, will be binding on such trading member. Approved user shall be required to change his password
at the end of the password expiry period.

10.3.3 Trading Days

Presently the Exchanges operate on all days except Saturdays, Sundays and declared trading holidays.
Trading for agri and non agri commodity derivative contracts takes place from Monday to Friday.

The types of order books, trade books, price limits, matching rules and other parameters pertaining to
trading sessions are specified by the Exchange to the members via its circulars or notices issued
periodically. Members can place orders on the trading system during trading sessions, within the
regulations prescribed by the Exchange as per the byelaws, rules and regulations. Trading hours and
trading cycle.

From time to time, the Exchange announces the normal trading hours/open period in advance as approved
by SEBI.

With effect from Monday, December 31, 2018 trade timings have been revised as under .

Particulars Current Trade Revised Trade Revised Client Code

Timings Timings Modification Timings

Crude Palm Oil, Cotton, Kapas, Soy Oil and 10:00 a.m. to 9:00 a.m.
9:00 p.m. to 9:15 p.m.
Sugar 9:30 p.m. to 9:00 p.m.

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 10:00 a.m. to 9:00 a.m.
All Other Agri Commodities 5:00 p.m. to 5:15 p.m.
5:00 p.m. to 5:00 p.m.

However, non-agricultural commodities timings will remain unchanged from 10 am to 11.30/11.55 pm

(depending on the Daylight Saving Calendar published by the US Government).

Consequent to change in trade timings – following further changes have also come into being:

 The Pre-Open session from 8:45 a.m. to 9:00 a.m. for all commodities.

 On the contract expiry date, expiring contracts is available for trade till 5:00 p.m.

10.3.4 Opening of Contracts

Trading in any contract month opens on the 1st day of the month. If 1st happens to be a non-trading day,
contracts would open on the next trading day.

10.3.5 Contract Expiration

Derivatives contracts expire on a pre-determined date and time up to which the contract is available for
trading. This is notified by the Exchange in advance. The contract expiration period will not exceed twelve
months or as the Exchange may specify periodically.

At NCDEX, 20th day of the delivery month is the date of expiry for most of the contracts. However, some
of the agri, metals and energy contracts expire on different dates. If 20th (or date of expiry) happens to be
a holiday, the expiry date shall be the immediately preceding trading day of the Exchange, other than a
Saturday.

10.3.6 Trading Parameters

The Exchange specifies various trading parameters relating to the trading system. Every trading member
is required to specify the buy or sell orders as either an open order or a close order. The Exchange also
prescribes different order books that shall be maintained on the trading system and also specifies various
conditions on the order that will make it eligible to place it on those books.

The Exchange specifies the minimum disclosed quantity for orders that will be allowed for each
commodity/derivatives contract. It also prescribes the number of days after which the ‘Good Till Cancelled’
orders will be cancelled by the system. The Exchange also specifies parameters like lot size in which orders

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can be placed, price steps in which orders shall be entered on the trading system and position limits in
respect of each commodity.

10.3.7 Failure of Trading Member Terminal

In the event of failure of trading member’s workstation or the loss of access to the trading system, the
Exchange can, at its discretion, undertake to carry out on behalf of the trading member, the necessary
functions, which the trading member is eligible for. Clear and precisely written requests by the trading
member only would be considered. The trading member is accountable for the functions executed by the
Exchange on its behalf and has to indemnify the Exchange against any losses or costs incurred by the
Exchange.

10.3.8 Trade Operations

Trading members must ensure that appropriate confirmed order instructions are obtained from the
constituents before placement of an order on the system. They must keep relevant records or documents
concerning the order. The trading system order number and copies of the order confirmation
slip/modification slip must be made available to the constituents.

The trading member must disclose to the Exchange at the time of order entry whether the order is on his
own account or on behalf of constituents and specify orders for buy or sell as open or close orders. Trading
members are solely responsible for the accuracy of order details entered into the trading system including
orders entered on behalf of their constituents. Trades generated on the system are irrevocable and ‘locked
in’. Periodically, the Exchange specifies the market types and the manner, in which trade cancellation can
be effected. Where a trade cancellation is permitted and trading member wishes to cancel a trade, it can
be done only with the approval of the Exchange.

10.3.9 Margin Requirements

Subject to the provisions as contained in the Exchange bye-laws and such other regulations, as may be in
force, every clearing member, in respect of the trades to which he is a party, must deposit a margin with
Exchange authorities/clearing house.

Periodically, the Exchange prescribes the commodities derivative contracts, the settlement periods and
trade types for which margin would be attracted. The Exchange levies initial margin on derivatives contracts
using the concept of Value at Risk (VaR) or any other concept as the Exchange may decide periodically.
Additional margins may be levied for deliverable positions, based on VaR from the expiry of the contract
till the actual settlement date plus a mark-up for default.

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The margin must be deposited with the Exchange within the time notified by the Exchange. The Exchange
also prescribes categories of securities that would be eligible for a margin deposit, as well as the method
of valuation and amount of securities that would be required to be deposited against the margin amount.
The procedure for refund/adjustment of margins is also specified by the Exchange periodically. The
Exchange can impose upon any trading member or category of trading members any special or other
margin requirement. On failure to deposit margins as required under this clause, the Exchange/clearing
house can withdraw the trading facility of the trading member. After the payout, the clearinghouse releases
all margins.

10.3.10 Unfair Trading Practices

No trading member should buy, sell, deal in derivatives contracts in a fraudulent manner, or indulge in any
unfair trade practices including market manipulation. This includes the following:

 Take part directly or indirectly either in transactions, which are likely to have effect of artificially,
raising or depressing the prices of spot/derivatives contracts.

 Indulge in any act, which is calculated to create a false or misleading appearance of trading,
resulting in reflection of prices, which are not genuine.

 Buy, sell commodities/contracts on his own behalf, or on behalf of a person associated with him
pending the execution of the order of his constituent or of his company or director for the same
contract.

 Delay the transfer of commodities in the name of the transferee.

 Indulge in falsification of his books, accounts and records for the purpose of market manipulation.

 When acting as an agent, execute a transaction with a constituent at a price other than the price
at which it was executed on the Exchange.

 Take opposite position to an order of a constituent or execute opposite orders, which he is holding
in respect of two constituents except in the manner laid down by the Exchange.

10.3.11 Clearing

Clearing houses under take clearing operations for trades executed on any exchange. Similarly NCCL
undertakes clearing of trades executed on the NCDEX. All deals executed on the Exchange are cleared
and settled by the trading members on the settlement date by the trading members themselves as clearing
members or through other professional clearing members in accordance with the regulations, bye-laws and
rules of the Exchange.

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10.3.12 Last Day of Trading

Last trading day for a derivative contract in any commodity is the date as specified in the respective
commodity contract. If the last trading day as specified in the respective commodity contract is a holiday,
the last trading day is taken to be the previous working day of the Exchange.

10.3.13 Delivery

Delivery can be done through the clearinghouse or outside the clearinghouse. During a specific period as
decided by the Exchange for different types of commodity futures, the Exchange provides a window on the
trading system to submit delivery information for all open positions.

After the trading hours during the tender period and on the expiry date, based on the available information,
the matching for deliveries takes place – firstly, on the basis of locations and then randomly keeping in view
the factors such as available capacity of the vault/ warehouse, commodities already deposited and
dematerialized and offered for delivery and any other factor as may be specified by the Exchange
periodically. Matching done is binding on the clearing members. After completion of the matching process,
clearing members are informed of the deliverable/receivable positions and the unmatched positions.
Unmatched positions must be settled in cash. The cash settlement is only for the incremental gain/loss as
determined since final settlement price. (Cash settlement and/or settlement through physical settlement
happens depending upon the type of contract – discussed in detail else where in the book)

All matched and unmatched positions are settled in accordance with the applicable settlement calendar.
The Exchange may allow an alternate mode of settlement between the constituents directly. This will be
allowed only if both the constituents, through their respective clearing members, notify the Exchange before
the closing of trading hours on the expiry date. They have to mention their preferred identified counter-
party and the deliverable quantity, along with other details required by the Exchange. The Exchange
however, will not be responsible or liable for such settlements or any consequence of such alternate mode
of settlements. If the information provided by the buyer/seller clearing members fails to match, then the
open position would be settled in cash together with penalty as may be stipulated by the Exchange. The
clearing members can deliver their obligations before the pay-in date as per applicable settlement calendar,
whereby the clearing house can reduce the margin requirement to that extent.

The Exchange specifies the parameters and methodology for premium/discount periodically, for the
quantity/quantity differential, taxes, government levies/fees if any. Pay in/Pay out for such additional
obligations are settled on the supplemental settlement date as specified in the settlement calendar.

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10.3.14 Procedure for Payment of Applicable Taxes

The Exchange prescribes procedure for payment of applicable taxes or any other or fee applicable to the
deals culminating into sale with physical delivery of commodities. Delivery through the depository clearing
system.

Delivery in respect of all deals for the clearing in commodities happens through the depository clearing
system. The delivery through the depository clearing system into the account of the buyer with the
depository participant is deemed to be delivery, notwithstanding that the commodities are located in the
warehouse along with the commodities of other constituents. NCDEX uses E-Repository System of NERL
for this purpose. Functions of E-Repository System discussed later in this chapter.

10.3.15 Payment through the Clearing Bank(S)

Payment in respect of all deals for the clearing must be made through the clearing bank(s). It is provided
however that the deals of sales and purchase executed between different constituents of the same clearing
member in the same settlement shall be offset by process of netting to arrive at net obligations.

10.3.16 Clearing and Settlement Process

The relevant authority periodically fixes the various clearing days, the pay-in and pay-out days and the
scheduled time to be observed in connection with the clearing and settlement operations of deals in
commodities/futures contracts.

 Settlement obligations statements for TCMs

The Exchange generates and provides to each trading cum clearing member, settlement
obligations statements showing the quantities of the different kinds of commodities for which
delivery/deliveries is/are to be given and/or taken and the funds payable or receivable by him in his
capacity as clearing member and by professional clearing member for deals made by him for which
the Clearing Member has confirmed acceptance to settle.

The obligations statement is deemed to be confirmed by the trading member for which deliveries
are to be given and/or taken and funds to be debited and/or credited to his account as specified in
the obligations statements and deemed instructions to the clearing banks/institutions for the same.

 Settlement obligations statements for PCMs and STCMs

The Exchange/clearing house generates and provides to each PCM and STCM , settlement obligations
statements showing the quantities of the different kinds of commodities for which delivery/deliveries is/are

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to be given and/or taken and the funds payable or receivable by him. The settlement obligation statement
is deemed to have been confirmed by the said clearing member in respect of each obligation enlisted
therein.

Delivery of commodities

Based on the settlement obligations statements, the Exchange generates delivery statement and receipt
statement for each clearing member. The delivery and receipt statement contains details of commodities
to be delivered to and received from other clearing members, the details of the corresponding buying/selling
constituent and such other details. The delivery and receipt statements are deemed to be confirmed by the
respective member to deliver and receive on account of his constituent, commodities as specified in the
delivery and receipt statements. On the respective pay-in day, clearing members affect depository delivery
in the depository clearing system, as per delivery statement in respect of depository deals. Delivery has to
be made in terms of the delivery units notified by the Exchange.

Commodities, which are to be received by a clearing member, are delivered to him in the depository clearing
system in respect of depository deals on the respective pay-out day as per instructions of the
Exchange/clearinghouse.

Delivery units

From time to time, the Exchange specifies the delivery units for all commodities admitted to dealings on the
Exchange. Electronic delivery is available for trading before expiry of the validity date. The Exchange also
specifies the variations permissible in delivery units as per those stated in contract specifications.

New Depository System: E-Repository System

All clients and members who are desirous of delivering and receiving commodities on the Exchange
platform are required to open accounts in E-Repository System. The Exchange had taken a view to design
and implement its own software application for maintaining electronic record of commodities deposited in
the warehouses accredited by the Exchange to avoid being totally dependent on third parties for such
services such as NSDL and CDSL. The Exchange has already shifted to E-Repository System, the activity
of maintenance of electronic record of stocks deposited in the warehouses accredited by the Exchange, in
respect of majority of commodities traded on its platform. It is a user-friendly web based application
connecting the Exchange, warehouses, assayers, members, RPs, investors and clients.

Repository Participant (RP) is a bank or a financial institution that has executed an agreement with NERL
and is approved for opening and maintaining accounts of its clients in the electronic accounting system
known as E-Repository System, owned and maintained by NERL. Depository Participants can become
Repository Participant. All clients participate in delivery of commodities only through RP. On creation of

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client account, RP allocates a unique code to that client, only then the client is eligible to deposit
commodities.

Depositing Commodity on E-Repository System

Box 10.2: COMTRACK ®: Formerly Exchange used COMTRACK in place of E-Repository System,
following is the brief on the COMTRACK.

COMTRACK® is an electronic web-based system developed and implemented by the Exchange, which
facilitates electronic accounting of commodities deposited in the warehouses approved by the Exchange.
COMTRACK® facilitates transfer of such deposited commodities against the obligations arising out of the
trades executed on the Exchange trading platform under the Clearing and Settlement process of the
Exchange. This system is being updated to E-Repository System.

COMTRACK is the platform that is built from ground up as a commodities registry. COMTRACK is owned
and maintained by NERL. It is a web based application with no specific hardware requirements. While
retaining relevant features of existing depository platform, COMTRACK addresses the needs specific to
manage a commodities.

COMTRACK incorporates best practices and Standard Operating Procedures for a commodity
warehouse, like:

 Electronic holding, transfer & Settlement of Commodities.

 Tracing of original depositor for a particular lot.

 Disallowance of off market transfer for fractional quantities.

 Flexibility for acceptance of smaller quantities from farmers

 No need for involvement of intermediaries like R&TA etc.

 Unique lot number associated with every deposit.

 Reduced cost and time for depositors

 Co-relation of physical storage and electronic records (right down to grade, net weight, bay
and stack no)

COMTRACK® is a one point contact which brings all entities like Investors, Warehouses, Assayers,
Repository Participants (RPs), Clearing Members (CMs), Clearing Corporation (CC) and the Exchange
involved in the Physical Settlement process of Commodities on one common electronic platform.

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If the commodity meets the quality specifications a receipt number is generated and provided to the client.
The credit is given lot wise in E-Repository System. The grades and the location would be ‘tagged’ to this
lot number which would be a unique combination.

On the settlement day the client should ensure that the commodity is transferred in the members pool
account. Settlement system related to the E-Repository System will be explained in detail in this book while
discussing final settlement.

10.4 Rules Governing Investor Grievances, Arbitration

In matters where the Exchange is a party to the dispute, the civil courts at Mumbai have exclusive
jurisdiction in respect of NCDEX. In all other matters, proper courts within the area covered under the
respective regional arbitration centre have jurisdiction in respect of the arbitration proceedings falling/
conducted in that regional arbitration centre. In case of NCDEX, there are four regional arbitration centre
in Mumbai, New Delhi, Kolkatta and Chennai. Each ISC of the Exchange has dedicated ISC official to
counsel, receive, record the grievance/complaints of the investors and extend various levels of dispute
resolution to the investors.

For the purpose of clarity, following definitions used:

 Arbitrator means a sole arbitrator or a panel of arbitrators

 Applicant means the person who files the application for initiating arbitral proceedings

 Respondent means the person against whom the applicant lodges an arbitration application,
whether or not there is a claim against such person

If the value of claim, difference or dispute is more than Rs. 25 lakh on the date of application, then such
claim, difference or disputes are to be referred to a panel of three arbitrators. If the value of the claim,
difference or dispute is up to Rs. 25 lakh, then they are to be referred to a sole arbitrator. Where any claim,
difference or dispute arises between agent of the member and client of the agent of the member, in such
claim, difference or dispute, the member, to whom such agent of the member is affiliated, is impleaded as
a party.

In case, the warehouse refuses or fails to communicate to the constituent the transfer of comodities, the
date of dispute is deemed to have arisen on:

 The date of receipt of communication of warehouse refusing to transfer the commodities in favour
of the constituent

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  The date of expiry of 5 days from the date of lodgement of dematerialised request by the constituent
for transfer with the seller, whichever is later

10.4.1 Procedure for Arbitration

The applicant must submit to the Exchange an application for arbitration in the specified form.

If any deficiency or defect is found in the application, the Exchange calls upon the applicant to rectify the
deficiency or defect and the applicant must rectify the deficiency or defect within 15 days of receipt of
intimation from the Exchange.

If the applicant fails to rectify the deficiency or defect within the prescribed period, the Exchange returns
the deficient or defective application to the applicant. However, the applicant has the right to file a revised
application, which will be considered as a fresh application for all purposes and dealt with accordingly.
Upon receipt of the form the Exchange forwards a copy of the statement of case and related documents to
the respondent. The respondent has to then submit his response in the prescribed form to the Exchange
within 7 days from the date of receipt. If the respondent fails to submit the form within the time period
prescribed by the Exchange, then the arbitrator is appointed in the manner as specified in the regulation.

10.4.2 Hearings and Arbitral Award

No hearing is required to be given to the parties to the dispute, if the value of the claim, difference or dispute
is Rs. 25,000 or less. In such a case, the arbitrator proceeds to decide the matter on the basis of documents
submitted by both the parties. However, the arbitrator for reasons to be recorded in writing may hear both
the parties to the dispute.

If the value of claim, difference or dispute is more than Rs. 25,000, the arbitrator offers to hear the parties
to the dispute unless both parties waive their right for such hearing in writing.

The Exchange in consultation with the arbitrator determines the date, time and place of the first hearing.
Notice for the first hearing is given at least ten days in advance, unless the parties, by their mutual consent,
waive the notice. The arbitrator determines the date, time and place of subsequent hearings of which the
Exchange gives a notice to the parties concerned.

If after the appointment of an arbitrator, the parties settle the dispute, then the arbitrator records the
settlement in the form of an arbitral award on agreed terms. All fees and charges relating to the appointment
of the arbitrator and conduct of arbitration proceedings are to be borne by the parties to the reference,
equally or in such proportions as may be decided by the arbitrator. The costs, if any, are awarded to either
of the party, in addition to the fees and charges, as decided by the arbitrator.

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Further the complainant can also lodged their complaint/grievance through SEBI website SCORES. The
Exchange has dedicated email id : ig@ncdex.com for the investor to lodge their complaints directly through
email.

Arbitration process in simple terms can be summarised as under:

 The grievance is first received by ISC official and he/she take efforts to resolve same by taking up
the matter with concerned member.

 If the grievance is not resolved in spite of intervention of ISC official the same is transferred to
member of Investor Grievance Redressal Panel (IGRP) who is independent expert. IGRP member
issues Order which in favour of either party.

 If the IGRP order is in favour of investor/client and member do not abide by it the next level dispute
resolution mechanism of arbitration is extended to the parties.

 The Arbitrator (judge) deals with unresolved IGRP matter and issue an Award(Order) which may
be in favour of either party.

 The arbitration matter which do not get settle post arbitration, can be referred to Appellate
arbitration by aggrieved party.

 The Exchange has different panel for arbitration and appellate arbitration.

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Module 11 : Taxes
11.1 Commodity Transaction Tax (CTT)

Introduced in the Finance Act, 2013, Commodity Transaction Tax (CTT) came in force with effect from 1st
July 2013 on the sale transactions of commodity futures at the rate of 0.01 percent. CTT is applicable on
all non-agri commodities futures trade however some select agri commodities are exempted. This tax is
payable by the seller.

The procedure followed by the Exchange (NCDEX) regarding CTT is as follows:

 CTT is determined at the end of each trading day.

 For the purpose of calculation of CTT, transactions are identified based on the client code entered
by the members at the time of order entry on the Exchange trading system and as may be modified
by the member using the client code modification facility provided by the Exchange within the
prescribed time. In respect of proprietary transactions the member code shall be deemed to be the
client code.

 The value of taxable commodities transaction is determined with respect to the transaction
executed under a particular client code. For each client code, all the sell transactions for a trading
day is aggregated at the contract level.

 For the purpose of determining CTT liability, the taxable commodities transaction is valued at the
actual traded price. On this value, the CTT rate as prescribed is applied.

 The trading member’s CTT liability is the aggregate CTT liability of clients trading through him and
the clearing member’s CTT liability is the aggregate CTT liability of all trading members clearing
under him.

Process with regard to the implementation of the collection of CTT is as under:

 A report is provided to the members at the end of each trading day. This report contain information
on the total CTT liability, trading member wise CTT liability, client wise CTT liability and the detailed
computations for determining the client wise CTT liability.

 The CTT amount is collected from the Clearing Member as per the timelines stipulated for the funds
pay-in on a daily basis. A separate transaction is created and the amount is collected from the
settlement account of members through their clearing banks as per the process currently followed
in respect of settlement obligations. Non-payment of CTT is treated as non-fulfillment of settlement
obligations for the purpose of all consequential actions against the member.

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  The contract notes issued to clients by the members on a daily basis should specify the total
commodities transaction tax for the transactions mentioned therein. Members may issue the CTT
details on annual basis (within one month from the close of the financial year) to their respective
clients, unless required by the clients otherwise.

11.2 Taxation Updates Post 2018-19 Budget:

CTT of 0.01% was collected from sellers of on non-farm and processed farm commodity derivatives. Those
commodities which did not attract CTT were deemed to be speculative traders where losses or gains arising
out of such trades could be set off only against other speculative profits or losses and not business income.

This especially hurt agri hedgers who, to protect price risk, would take opposite positions on the derivatives
markets to those they had taken on the physical market. However, since no CTT was paid on, say guar or
soyabean futures, the losses incurred on the derivatives market could not be set off against their business
income on the physical market.

The Finance Minister in his Budget for FY19 rectified by introduction of a clause (e) to proviso 5 of Section
43. Which stipulates that non delivery commodity trades carried out on a recognised stock exchange or
registered associations would not be treated as a speculative transaction. This would enable a hedger of
agri produce to set off loss or gain on commodity exchanges against physical market profit or loss treated
as business income.

In another significant move, the CTT on devolvement of a commodity options -- converting option to futures
position was kept at 0.0001% and not 0.125% prevalent on options that are exercised.

As explained earlier options in commodities, unlike in equities, are derived from their respective futures
contracts as the spot market in agri is controlled by respective state governments. Gold options are based
on gold futures. Anybody wishing to exercise a gold options has to convert it into a gold futures. On NCDEX,
guar options are traded when exercised get converted to corresponding future contract.

11.3 Goods and Services Tax (GST)

GST is payable by the members of the Commodity Exchanges on the gross amount charged by them, from
their clients on account of dealing in commodities.

GST on the deliveries effected on the Exchange Platform as the case may be would be applicable on the
delivered commodities and a buyer on the Exchange platform makes payment to his corresponding seller
the value of GST payable by buyer on the commodities received by the seller in the Exchange settlement.
The buyer and the seller are solely responsible for fulfillment of the obligations under the GST act on all
contracts. The is required to issue appropriate invoices to his corresponding buyer as may be required

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under the GST act from time to time . The seller is required to remit the GST amount so collected/received
from the buyer wherever applicable to the GST authorities within such time frame as may be prescribed
under the GST rules. Members and / or their constituents requiring to receive or deliver commodities
through exchange platform should register themselves with the relevant GST authorities of the place where
the delivery is proposed to be received / given. In the event of any GST exemptions, , such exemption
certificate as may be required under the GST law should be issued/provided to his seller before the
settlement of the obligation.

Exchange only facilitates payment of taxes from buyer to seller. However final payment of such taxes to
appropriate tax authorities is the sole responsibility of the seller and Exchange does not assume any
responsibility.

11.3.1 Settlement on Account of GST

Receiving clearing members are required to send GST information along with buying client details by 1500
hours on the next working day after the settlement day (E+3) as per settlement calendar.

If a receiving member fails to provide GST information within the stipulated time, it is assumed that the
delivery is taken by member himself and accordingly relevant information is provided to concerned
delivering members and the invoices are raised in the name of the receiving member.

GST information for each delivery transaction submitted by the receiving clearing members is passed on
by the Exchange to the concerned delivering clearing members. The buyer client details and GST
information (exemption form numbers, if any) as provided in the report are passed on by the delivering
clearing member to their seller clients for computing GST obligations and generating invoices. The Clearing
Corporation provides this report to the delivering clearing members by the evening of the next working day
after the settlement date.

The delivering clearing members are required to provide the information by 1500 Hours on or before the
2nd working day after the settlement date (E+4). Based on the GST information submitted by the delivering
clearing member, GST settlement obligation is determined. GST settlement of funds is completed on 3rd
working day after the settlement date (E+5).

If the delivering member fails to submit GST information, it is assumed that there is no GST settlement to
be carried out for deliveries made by him.

11.3.2 Invoicing

After the tax obligations are determined, the seller clients must raise the invoices. The relevant tax will be
based on quality/quantity delivered by seller.

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The Delivery value for tax is computed using the following formula:

 Delivered quantity X (Final settlement price + or – Premium/discount for grade actually delivered).
The tax invoice should clearly specify, among other things, the delivery receipt number, the client
name and address, the trading member-id of the seller member and buyer member as per relevant
GST rules as applicable from time to time and whether Composite Tax scheme availed.

The delivering Clearing Member/its Constituent tendering delivery during staggered period/up on the expiry
of contract will have provide details of invoice and all other documents including mandi related which are
mandatorily required by T/E+5 day.

The delivering Clearing Member / Constituents shall dispatch the settlement related documents to reach
the receiving Clearing Member / Constituent latest by T/E+7.

The receiving Clearing Member / Constituent is required to inform discrepancy/non receipt of invoices or
any settlement related document including mandi tax paid certificate/receipt etc. or other required
information to the Exchange by T/E+9 day.

In the event of non-receipt of any such reference of discrepancies if any in respect of the delivery related
documents within the said period, the counter parties (i.e, sellers and the buyers) shall be deemed to have
exchanged all requisite documents and information.

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Module 12 : Electronic Spot MARKET
Currently all agricultural commodities are traded in the physical markets or mandis. The regular practice
followed is that on harvest the farmers bring their produce to these mandis and dispose of the same through
either bilateral negotiations or through an auction process. Bilateral trade happens largely in those cases
where the concerned farmer is indebted to a particular Arathiya or Commission agent. It is a known fact
that the farmer gets only a small fraction of what ultimate consumer pays for agricultural commodities and
a significant part of their income is consumed in servicing intermediaries in the form of commission, interest
burden, transportation and warehousing charges etc. A major portion of the loss in value of commodities
due to wastages, pest attack, transportation, storage, handling etc. is again borne by the farmer.

NCDEX has taken up an initiative to launch NCDEX e-Markets Limited (NeML, Formerly NCDEX Spot
Exchange-NSPOT) at the national level on October 18 2006. NeML is a wholly owned subsidiary of NCDEX
(majority owned by LIC, NABARD, IFFCO, PNB, Canara Bank, NSE). Over the years, NeML is the leading
Indian electronic web based, online, commodities spot market and services company. It combines best
features of financial markets and spot markets.

Such a national level platform has pave the way for participation by participants/entities irrespective of
geographical locations. It also empowered the farmers by virtue of the electronic platform which would
extend the reach to buyers across the length and breadth of the country.

12.1 Need for Electronic Online Spot Market

 The online, electronic spot market NeML has brought the buyers and sellers (Traders and Farmers)
closer to each other and help in actual price discovery between the buyer and seller directly.

 Further, NeML facilitates

a) Wider reach (Not only in the State of residence of farmers but throughout India as against
presently local Mandis only) in order help improve the realisation of producers/farmers.

b) Liquidity - The large number of quotes from various buyers and sellers throughout the country
enhances the liquidity of contracts. Any quantity of goods can be bought and sold instantly.

c) Counter Party Guarantee: Risk Mitigation - Exchange stands guarantee for payment to seller
and for delivery of goods to buyer.

d) Timely settlement

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  The warehousing and online electronic trade will help the buyers and sellers to manage their
finances and inventory better. It also enhances holding power of farmers by providing warehousing
facilities at lower cost and also Bank loan facilities till goods are sold.

 NeML’s online electronic trading platform helps make the market a transparent, fair and objective
marketplace.

 Helps enhance government ( Mandi Cess/Taxes) by reducing the possibility of manipulation and
pilferage (lower billing / tempering of rates due to transactions being fully computerized without any
human intervention.

 Boost to Cooperative movement: Encourages farmers to form cooperative marketing societies who
will become members and sell the agriculture produce of small and marginal farmers through
process of aggregation etc.

With a national presence, NeML has pioneered breakthrough initiatives like Mandi Modernization Program
(MMP), e-Pledge, and e-marketing. NeML works closely with its ecosystem partners to create efficient
commodity markets its market and services. E-marketing facilitates buyers and sellers enhance their buying
and selling efficiencies leveraging its trading platform. The company helps in financial inclusion by
facilitating credit to smallholders against commodities stored in NeML and Bank approved warehouses
using its unique e-pledge mechanism. In the process NeML helps in leveraging market by the farmers
along with helping consumers get supplies on time.

Unified Market Platform / Karnataka Model

Mandi Modernization Program initiative by NeML envisioned to transform the regulated, fragmented Indian
Agricultural markets, popularly known as APMC Markets/ Mandi into a single unified agricultural market
leveraging its Unified Market Platform (UMP). It uses "one state one market" as the building block to
achieve this vision. Since MMP made a beginning in the state of Karnataka, the model is widely recognized
as the "Karnataka model" by various government and government entities. Impressed by the work done,
central government has adopted the principles as National Agriculture Market (NAM).

12.1.1 E-Pledge Helps in Financial Inclusion

To help farmers and processor get easy access to finance NeML has started the electronic pledging of
commodities deposited in the market accredited warehouses. NeML acts as facilitator to bring the
warehouses, banks and clients under one electronic platform through its COMLIVE® system. In its brief
existence commodities worth Rs. 2150 Cr has been financed using e-Pledge with seven banks.

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12.1.2 Facilitating Farmer Producer Organizations (FPOs)

NeML facilitates FPOs in buying / selling of the farmers' produce using its trading platform. NeML has
worked with more than 60 FPOs benefitting more than 28000 farmers in the states of Maharashtra, Gujarat,
Rajasthan, Karnataka, Andhra Pradesh and Madhya Pradesh. It works closely with the institutions like
Small Farms Agri Business Consortium (SFAC) and Mother Dairy to help FPOs transaction.

12.1.3 Enabling Government Meets Its Social Objectives

NeML enables state governments fulfill its food security and price support initiatives leveraging its
ecosystems commodity participants, warehouse service providers, assayers and financial institutions.

NeML helps other central governmental organizations such as Food Corporation of India (FCI), NAFED,
SFAC, PEC and MMTC procure and sale agri-commodities under various food security programs.

12.1.4 Regulations

NeML is a Public limited company incorporated in October 2006. The operations of the company are
regulated in each state by the respective state governments and are subjected to various laws of the land
like the Companies Act, Stamp Act, Contracts Act, APMC Act and others which impinge on its working.

NeML is Self-Regulated Organization (SRO) working within the frame-work of existing rules and
regulations. We combine the stringent standards of a financial market for risk management and counter
party guarantee and offers markets that are closer to spot markets.

12.2 Service
12.2.1 E-Pledge

NeML offers e-Pledge model in which NeML act as facilitator, bringing borrower, Warehouse Service
Provider (WSP) and Bank under one roof, providing warehouse and commodity electronic accounting
system, Pledging, Trading, clearing and settlement solution. Borrowers (farmers / Traders / processors /
FPOs etc.) after depositing commodities in NeML notified warehouses can apply on-line to Bank via
Comlive and avail finance against pledge of warehouse receipts.

The physical warehouse receipt financing has been in existence for a long period of time where banks lend
against the physical warehouse receipts issued by warehouseman. Due to lack of MIS, redundant risk
management process, and lack of transparency Banks have faced many frauds and scams. NeML's e-
pledge warehouse based commodity finance model work towards removing such malfunctioning of the
system by offering better risk management, enhanced operations and technological solutions. NeML's

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empaneled Warehouse Service Provider (WSP) act as Collateral management agency responsible for
commodity safety, security, stock management, insurance, deposit and delivery whereas NeML provides
its e-pledging platform and better risk management process. E-pledge model ensures safe, speedy, smooth
and transparent commodity finance business transaction.

NeML also offers e-auction of defaulted stock (even in physical form) on its trading platform which has large
pool of buyers already registered at pan India level and Banks realize better prices for such commodities.

Benefits:

 E-pledge is simple, secure and speedy mode of commodity accounting and pledging platform

 Comlive Platform brings more visibility, traceability in the existing practices of WHR finance and
make entire process more secure.

 Enhanced monitoring of e-pledge transaction through regular e-mail alert services for various
aspects like pledge creation, Pledge redeem, price drop, insurance expiry, revalidation of
commodities etc.

 COMLIVE Platform ensures pledge monitoring and real time data accountability via providing
multiple customizable MIS reports.

 Regular internal as well independent third party audit and inspection of warehouses and
commodities to Maintain sanity of the operations

 Facility of online trading of pledged commodity, which leads to better realization to the borrowers.

 In case of Credit default, Default auction on NeML Platform for disposal and better Price Discovery

List of Pledgee Banks:

NeML has tied-up with Leading Banks for extending e-pledge finance services to borrowers:

 State Bank of India

 IDBI Bank

 Central Bank of India

 Punjab National Bank

 Corporation Bank

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  Vijaya Bank

12.2.2 Warehouse and Supply Chain

NCDEX e Markets Limited facilitates in providing complete supply chain management solution for its
customers on its trading platform.

Collateral management

NCDEX e Markets Limited has accredited reputed warehouse service providers as Collateral Managers for
the commodities traded on Spot exchange.

Logistics

As part of its effort to provide complete trading solutions NCDEX e Markets Limited helps participants by
linking them with dependable and reputed logistic service providers in select locations. We also provide
warehouses with accredited assayers.

Approved Warehouse Service:

NeML has empaneled various Warehouse Service Providers (WSP) for providing warehousing and related
services like commodity safety and maintenance, security, stock management, insurance, deposit and
delivery under various projects on NeML Platform. Some of the select WSP are also approved by various
bank for providing collateral management services

List of approved Warehouse Service Providers:

 LTC Commercial Company Private Ltd (Approved WSP for e-pledge)

 Kalyx Warehousing Pvt. Ltd (Approved WSP for e-pledge)

 Navjyoti Commodities Management Services Ltd. (Approved WSP for e-pledge)

 Total Logistics India Pvt. Ltd. (Approved WSP for e-pledge)

 Maharashtra State Warehousing Corporation (Approved WSP for e-pledge)

 Gujarat State warehousing Corporation (Approved WSP for e-pledge)

 Nokha Agro Services Pvt. Ltd.

 JICS Logistics Ltd.

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  National Bulk Handling Corporation

 Edelweiss Integrated Commodity Management Limited

 Capaxo Logistics Pvt. Ltd.

 CGR Collateral Management Service Pvt. Ltd.

 Abans Logistics (Pvt.) Ltd

 Gramco Infratech Pvt. Ltd.

 Buldana Urban co-operative credit society

12.2.3 Comlive

Comlive in web based low cost online inventory system integrated with NeML SPOT trading, e-pledge and
clearing settlement system. Comlive track deposit lot id right from creation till extinguish. It has various
users like warehouseman, assayer, depositor, buyer, Bank, Transporter, and Auditor.

Advantages:

 Web based on-line inventory management system.

 On-line depositor registration.

 Low cost warehouse based value added services.

 Warehouses connected on-line, real time data updation.

 Assayed and un-assayed commodities entry.

 Complete tracking from procurement till consumption of commodities.

 Linkages with Banks for pledge finance facility.

 On-line storage charges calculation.

 No separate cost for system maintenance, data server and user data maintenance.

 Unlimited warehouse code can be accommodated.

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Module 13 Model Test Paper
13.1 Questions

Q:1.Which of the following can be the underlying for a commodity derivative contract? [1 Mark]

a) Interest Rate

b) Euro-Indian Rupee

c) Gold

d) NIFTY

Q:2. Daily mark to market settlement is done …………….[2 Marks]

a) Till the date of contract expiry

b) As long as the contract makes a loss

c) On the last day of week

d) On the last trading day of the month

Q:3……………...is the actual process of exchanging money and goods.[1 Mark]

a) Transfer

b) Settlement

c) Netting

d) Clearing

Q:4………….work at making profits by taking advantage of discrepancy between prices of the same product
across different markets.[2 Marks]

a) Arbitragers

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 b) Speculators

c) Exchange

d) Hedgers

Q:5.A forward contract is an agreement between two entities to buy or sell the underlying asset at a future
date, at today's pre-agreed price.[2 Marks]

a) FALSE

b) TRUE

Q:6. Options trading in commodity take place in Indian commodity exchanges.[1 Mark]

a) TRUE

b) FALSE

Q:7.Commodity exchanges enable producers and consumer to hedge their ……………..given the
uncertainty of the future.[1 Mark]

a) seasonal risk

b) profit risk

c) production risk

d) price risk

Q:8.Which of the following is not true about the national level exchanges?[2 Marks]

a) Offers online trading

b) Recognised on permanent basis

c) Offers single commodity for trading

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 d) Volumes higher than regional exchanges

Q:9.Which of the following Exchange does not offer derivative trading in Soybean? [2 Marks]

a) LME

b) NCDEX

c) CBOT

d) Dalian Commodity exchange

Q:10…………….Exchanges provide real time, online, transparent and vibrant spot platform for
commodities. [1 Mark]

a) Electronic Spot

b) Regional

c) Futures

d) Stock

Q:11……………..can only trade through their account or on account of their clients and however clear their
trade through PCMs/STCMs.[1 Mark]

a) Trading cum Clearing Member

b) Trading Member

c) Commodity Participant

d) Associate Member

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Q:12.Trading cum Clearing member can carry out transactions on their own account and also on their
clients account.[2 Marks]

a) FALSE

b) TRUE

Q:13.The minimum networth requirement for PCM on the NCDEX is………………. [2 Marks]

a) 500 Lacs

b) 10 Lacs

c) 1000 Lacs

d) 100 lacs

Q:14.Members can opt to meet the security deposit requirement by way of……………. .[2 Marks]

a) Cash

b) Bank Guarantee

c) Fixed Deposit Receipts

d) All of the above

Q:15. Any person seeking to dematerialize a commodity has to open an account with an approved
………….[1 Mark]

a) Clearing house

b) Exchange

c) Depository Participant

d) Bank

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Q:16.The cash settlement is only for the incremental gain/ loss as determined on the basis of……………
[1 Mark]

a) Final settlement price

b) Average price for the day

c) Opening price.

d) Last traded price

Q:17.Unit of trading for Wheat at NCDEX is……………. .[1 Mark]

a) 1 MT

b) MT

c) 1 kg

d) 10 MT

Q:18.Some of the futures contract traded on NCDEX expires on day other than 20th of the month.[1 Mark]

a) True

b) False

Q:19. By using the currency forward market to sell dollars forward, an………….. can lock on to a rate today
and reduce his uncertainty.[1 Mark]

a) Importer

b) Speculator

c) Exporter

d) Arbitrager

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Q:20………..is the last day on which the futures contract will be traded, at the end of which it will cease to
exist.[1 Mark]

a) Redemption Date

b) Expiry Date

c) Exercise Date

d) Maturity Date

Q:21."A ………option gives the holder the right but not the obligation to buy an asset by a certain date for
acertain price."[1 Mark]

a) Put

b) ITM

c) OTM

d) Call

Q:22.Forward contracts are bilateral contracts and hence exposed to counter party risk.[1 Mark]

a) TRUE

b) FALSE

Q:23.An …………..option is an option that would lead to a zero cash flow to the holder if it were exercised
immediately.[1 Mark]

a) In the money

b) At the money

c) Out of the money

d) Put

Page 175
Q:24.A call option with a strike price of 150 trades in the market at premium of Rs.12. The spot price is
Rs.160. The time value of the option is Rs. …………..[2 Marks]

a) 12

b) 10

c) 2

d) 8

Q:25.A put option with a strike price of 150 trades in the market at Rs.8. The spot price is Rs.160. The
intrinsic value of the option is Rs. ……..[2 Marks]

a) 0

b) 8

c) 2

d) 10

Q:26.A trader buys three-month put options on 1 unit of gold with a strike of Rs.17000/10 gms at a premium
of Rs.70. Unit of trading is 1kg. On the day of expiration, the spot price of gold is Rs.16800/10 gms. What
is his net payoff?[4Marks]

a) (+) 13,000

b) (+) 20,000

c) (-) 13,000

d) (-) 20,000

Q:27. One unit of trading for Guar Seed futures is 10 MT and delivery unit is 10 MT. A trader sells 1 unit of
Guar Seed at Rs.2500/Quintal on the futures market. A week later Guar Seed futures trade at
Rs.2550/Quintal. How much profit/loss has he made on his position? [2 Marks]

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 a) (-)5000

b) (+)5000

c) (+)50,000

d) (-)50,000

Q:28.The ………………position is considered for exposure and daily margin purposes.[2 Marks]

a) Short

b) Long

c) Net

d) Open

Q:29.Whenever the futures price moves away from the fair value, there would be opportunity for arbitrage.
[2 Marks]

a) FALSE

b) TRUE

Q:30. Consider a three-month futures contract on gold. The fixed charge is Rs.310 per deposit and the
variable storage costs are Rs.52.5 per week. Assume that the storage costs are paid at the time of deposit.
Assume further that the spot gold price is Rs.15000 per 10 grams and the risk-free rate is 7% per annum.
What would the price of three month gold futures if the delivery unit is one kg? Assume that 3 months are
equal to 13 weeks.[4 Marks]

a) 15,27,491

b) 16,24,511

c) 17,41,200

d) 15,00,200

Page 177
Q:31. On the 15th of June a firm involved in spices exports knows that it will receive 3 MT of Pepper on
August 15. The spot price of pepper is Rs.12680 per kg and the August Pepper futures price is Rs.13930.
A unit of trading is 1 MT and the delivery unit is 1 MT. The exporter can hedge his position by…………….
[4 Marks]

a) Buying 3 unit of August pepper futures

b) Buying 15 units of August Pepper futures

c) Selling 3 unit of August Pepper futures

d) Selling 15 units of August Pepper futures559.46

Q:32. A company knows that it will require 33,000 MT of Wheat in three months. The hedge ratio works out
to be 0.75. The unit of trading is 10 MT and the delivery unit for wheat on the NCDEX is 10 MT. The
company can obtain a hedge by……………. [4 Marks]

a) buying 450 units of three-month wheat futures.

b) selling 2475 units of three-month wheat futures

c) selling 450 units of three-month wheat futures.

d) buying 2475 units of three-month wheat future

Q:33.Gold trades at Rs.16000 per 10 gms in the spot market. Three-month gold futures trade at Rs.16150.
One unit of trading is 1kg and the delivery unit for the gold futures contract on the NCDEX is 1 kg. A
speculator who expects gold prices to rise in the near future buys 1 unit of gold futures. Two months later
gold futures trade at Rs.15900 per 10 gms. He makes a profit/loss of………..[2 Marks]

a) (+)2500

b) (+)25,000

c) (-)2500

d) (-)25,000

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Q:34.When the futures price of a commodity appears underpriced in relation to its spot price, an opportunity
for…………. arbitrage arises. [2 Marks]

a) reverse cash and carry

b) cash and carry

Q:35.A company that wants to sell an asset at a particular time in the future can hedge by taking short
futures position.[2 Marks]

a) TRUE

b) FALSE

Q:36.A order, is an order which is valid for the day on which it is entered.[1 Mark]

a) Good till offset

b) Good till day

c) Good till filled

d) Good till cancelled

Q:37.A Spread order is an order to buy or sell a stated amount of a commodity at a specified price, or at a
better price, if obtainable at the time of execution.[1 Mark]

a) FALSE

b) TRUE

Q:38. TMCFGRNZM is a symbol for the …………….futures contract traded on NCDEX: [1 Mark]

a) Copper

b) Tur

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 c) Turmeric

d) Crude Oil

Q:39.A trader sells 5 units of Jeera futures at Rs.16500 per Qunital. What is the value of his open short
position? Unit of trading is 1 MT and delivery unit is One MT.[2 Marks]

a) Rs.82,500

b) Rs.82,50,000

c) Rs.8,25,000

d) Rs.82,000

Q:40.The total number of outstanding contracts (long/short) at any point in time is called………………..[2
Marks]

a) Hedge Limit

b) Transaction Charge

c) Delivery Lot

d) Open Interest

Q:41. A trader has sold crude oil futures at Rs.3750 per barrel. He wishes to limit his loss to 20%. He does
so by placing a stop order to buy an offsetting contract if the price goes to or above…….[2 Marks]

a) Rs.4650

b) Rs.4500

c) Rs.3825

d) Rs.3925

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Q:42.In case the members/constituents are not registered under relevant tax laws with the state in which
delivery is affected, they can appoint a Carrying & Forwarding (C&F) agent who would undertake the
activities related to the physical delivery of the commodity. [1 Mark]

a) FALSE

b) TRUE

Q:43. A trader requires to take a long Jeera futures position worth Rs.15,30,000 as part of his hedging
strategy. Two month futures trade at Rs.17000 per Quintal. Unit of trading is 3 MT and delivery unit is 3
MT. How many units must he purchase to give him the hedge? [2 Marks]

a) 3 units

b) 1 units

c) 5 units

d) 10 units

Q:44. A trading member has proprietary and client positions in a March Chilli futures contract. On his
proprietary account, he bought 700 trading units at Rs.6000 per Quintal and sold 250 at Rs.6015 per
Quintal. On account of client A, he bought 200 trading units at Rs.6012 per Quintal, and on account of
client B, he sold 100 trading units at Rs.5990 per Quintal. What is the outstanding position on which he
would be margined? [3 Marks]

a) 750

b) 950

c) 450

d) 850

Q:45. If the last trading day as specified in the respective commodity contract is a holiday, the last trading
day is taken to be the previous working day of the Exchange. [1 Mark]

a) TRUE

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 b) FALSE

Q:46.A bread manufacturer bought five one-month wheat futures contracts at Rs.1155 per Quintal at the
beginning of the day. The unit of trading is 10 MT and each contract is for delivery of 10 MT. The settlement
price at the end of the day was Rs.1165 per Quintal. The trader's MTM account will show [4 Marks]

a) (-)2500

b) (+)2500

c) (+)5000

d) (-)5000

Q:47.Proprietary positions are netted at member level without any set-offs between client and proprietary
positions.[1 Mark]

a) TRUE

b) FALSE

Q:48. The commodities cannot be revalidated after the Exchange Delivery Date (EDD). [1 Mark]

a) TRUE

b) FALSE

Q:49.On respective ………….day, clearing members effect depository delivery in the depository clearing
system as per delivery statement in respect of depository deals.[2 Marks]

a) Pay-in

b) Expiration

c) Settlement

d) Pay-out

Page 182
Q:50………….refers to issue of physical delivery against the credit in the demat account of the
constituent.[1 Mark]

a) Securitisation

b) De-materialisation

c) Re-materialisation

d) Liquidation

13.2 Correct Answers

Question No. Answers Question No. Answers
1 (c) 26 (a)
2 (a) 27 (a)
3 (b) 28 (d)
4 (a) 29 (b)
5 (b) 30 (a)
6 (a) 31 (c)
7 (d) 32 (d)
8 (c) 33 (d)
9 (a) 34 (a)
10 (a) 35 (a)
11 (b) 36 (b)
12 (b) 37 (a)
13 (c) 38 (c)
14 (d) 39 (c)
15 (c) 40 (d)
16 (a) 41 (b)
17 (d) 42 (b)
18 (a) 43 (a)
19 (c) 44 (a)
20 (b) 45 (a)
21 (d) 46 (c)
22 (a) 47 (a)
23 (b) 48 (a)
24 (c) 49 (a)
25 (a) 50 (c)

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